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LIMESTONE BANCORP, INC. - Quarter Report: 2015 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549 


 FORM 10-Q  

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended September 30, 2015

 

Or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

Commission file number: 001-33033

 

PORTER BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Kentucky

  

61-1142247

(State or other jurisdiction of

  

(I.R.S. Employer

incorporation or organization)   Identification No.)
     

2500 Eastpoint Parkway, Louisville, Kentucky

  

40223

(Address of principal executive offices)

  

(Zip Code)

 

(502) 499-4800

(Registrant’s telephone number, including area code)

 


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes      No  

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes      No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer      

Accelerated filer      

Non-accelerated filer  

Smaller reporting company  

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes      No 

 

Indicate the number of shares outstanding of each of the issuer’s class of common stock, as of the latest practicable date.

 

20,091,205 shares of Common Stock and 6,858,000 shares of Non-Voting Common Stock, no par value, were outstanding at October 31, 2015. 


 

 


INDEX 

 

   

Page

     

PART I –

FINANCIAL INFORMATION

  

ITEM 1.

FINANCIAL STATEMENTS

3

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

37

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

58

ITEM 4.

CONTROLS AND PROCEDURES

58

  

  

  

PART II –

OTHER INFORMATION

  

ITEM 1.

LEGAL PROCEEDINGS

59

ITEM 1A.

RISK FACTORS

59

ITEM 2.

UNREGISTERED SALES ON EQUITY SECURITIES AND USE OF PROCEEDS

59

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

59

ITEM 4.

MINE SAFETY DISCLOSURES

59

ITEM 5.

OTHER INFORMATION

59

ITEM 6.

EXHIBITS

59

   

 


PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

The following consolidated financial statements of Porter Bancorp, Inc. and subsidiary, PBI Bank, Inc. are submitted:

 

Unaudited Consolidated Balance Sheets for September 30, 2015 and December 31, 2014

Unaudited Consolidated Statements of Operations for the three and nine months ended September 30, 2015 and 2014

Unaudited Consolidated Statements of Comprehensive Loss for the three and nine months ended September 30, 2015 and 2014

Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended September 30, 2015

Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 and 2014

Notes to Unaudited Consolidated Financial Statements

 

 

 

PORTER BANCORP, INC.

Unaudited Consolidated Balance Sheets

(dollars in thousands except share data) 

 

   

September 30,

2015

   

December 31,

2014

 

Assets

               

Cash and due from banks

  $ 6,540     $ 14,169  

Interest bearing deposits in banks

    73,940       66,011  

Cash and cash equivalents

    80,480       80,180  

Securities available for sale

    146,837       190,791  

Securities held to maturity (fair value of $44,244 and $44,498, respectively)

    42,138       42,325  

Loans held for sale

    71       8,926  

Loans, net of allowance of $14,198 and $19,364, respectively

    610,216       605,635  

Premises and equipment, net

    19,109       19,507  

Other real estate owned

    29,177       46,197  

Federal Home Loan Bank stock

    7,323       7,323  

Bank owned life insurance

    9,381       9,167  

Accrued interest receivable and other assets

    6,748       7,938  

Total assets

  $ 951,480     $ 1,017,989  
                 

Liabilities and Stockholders’ Equity

               

Deposits

               

Non-interest bearing

  $ 106,160     $ 114,910  

Interest bearing

    771,733       811,931  

Total deposits

    877,893       926,841  

Repurchase agreements

          1,341  

Federal Home Loan Bank advances

    3,255       15,752  

Accrued interest payable and other liabilities

    11,249       10,640  

Subordinated capital note

    4,275       4,950  

Junior subordinated debentures

    21,000       25,000  

Total liabilities

    917,672       984,524  

Stockholders’ equity

               

Preferred stock, no par

               

Series B - 0 and 40,536 issued and outstanding, respectively

          2,229  

Series D - 0 and 64,580 issued and outstanding, respectively

          3,552  

Series E - 6,198 issued and outstanding; Liquidation preference of $6.2 million

    1,644       1,644  

Series F - 4,304 issued and outstanding; Liquidation preference of $4.3 million

    1,127       1,127  

Total preferred stockholders’ equity

    2,771       8,552  

Common stock, no par, 86,000,000 shares authorized, 20,091,205 and 14,890,514 voting, and 6,858,000 and 0 non-voting shares issued and outstanding, respectively

    120,699       113,238  

Additional paid-in capital

    23,522       21,442  

Retained deficit

    (110,207

)

    (107,595

)

Accumulated other comprehensive loss

    (2,977

)

    (2,172

)

Total common stockholders’ equity

    31,037       24,913  

Total stockholders' equity

    33,808       33,465  

Total liabilities and stockholders’ equity

  $ 951,480     $ 1,017,989  

  

See accompanying notes to unaudited consolidated financial statements.

    

 

PORTER BANCORP, INC.

Unaudited Consolidated Statements of Operations

(dollars in thousands, except per share data) 

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2015

   

2014

   

2015

   

2014

 
Interest income                                

Loans, including fees

  $ 7,895     $ 8,201     $ 23,496     $ 25,094  

Taxable securities

    986       1,265       3,122       3,653  

Tax exempt securities

    187       231       580       707  

Fed funds sold and other

    111       117       351       423  
      9,179       9,814       27,549       29,877  

Interest expense

                               

Deposits

    1,476       2,245       4,775       6,925  

Federal Home Loan Bank advances

    23       31       74       96  

Subordinated capital note

    40       47       123       144  

Junior subordinated debentures

    158       153       465       458  

Federal funds purchased and other

          1       1       3  
      1,697       2,477       5,438       7,626  

Net interest income

    7,482       7,337       22,111       22,251  

Provision (negative provision) for loan losses

    (2,200

)

          (2,200

)

    6,300  

Net interest income after provision (negative provision) for loan losses

    9,682       7,337       24,311       15,951  
                                 

Non-interest income

                               

Service charges on deposit accounts

    492       535       1,376       1,490  

Bank card interchange fees

    212       209       644       575  

Other real estate owned rental income

    380       5       1,109       30  

Net gain on sales of securities

          46       1,696       92  

Gain on extinguishment of junior subordinated debt

    883             883        

Other

    243       262       763       734  
      2,210       1,057       6,471       2,921  

Non-interest expense

                               

Salaries and employee benefits

    3,920       4,041       11,795       11,731  

Occupancy and equipment

    815       857       2,513       2,645  

Professional fees

    620       361       2,313       1,134  

FDIC Insurance

    539       571       1,673       1,682  

Data processing expense

    278       269       860       818  

State franchise and deposit tax

    285       405       855       1,235  

Other real estate owned expense

    5,131       560       8,796       1,996  

Loan collection expense

    321       858       895       2,646  

Other

    1,059       1,359       3,694       3,700  
      12,968       9,281       33,394       27,587  

Loss before income taxes

    (1,076

)

    (887

)

    (2,612

)

    (8,715

)

Income tax benefit

          (38

)

          (1,345

)

Net loss

    (1,076

)

    (849

)

    (2,612

)

    (7,370

)

Less:

                               

Dividends on preferred stock

          786             2,361  

Loss allocated to participating securities

    (45

)

    (162

)

    (338

)

    (928

)

Net loss attributable to common shareholders

  $ (1,031

)

  $ (1,473

)

  $ (2,274

)

  $ (8,803

)

Basic and diluted loss per common share

  $ (0.04

)

  $ (0.12

)

  $ (0.10

)

  $ (0.73

)

 

See accompanying notes to unaudited consolidated financial statements. 

  

 

PORTER BANCORP, INC.

Unaudited Consolidated Statements of Comprehensive Loss

(in thousands)

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2015

   

2014

   

2015

   

2014

 

Net loss

  $ (1,076

)

  $ (849

)

  $ (2,612

)

  $ (7,370

)

Other comprehensive income (loss):

                               

Unrealized gain (loss) on securities:

                               

Unrealized gain arising during the period

    1,227       155       794       3,936  

Amortization during the period of net unrealized loss transferred to held to maturity

    33       82       97       149  

Reclassification adjustment for gains included in net income

          (46

)

    (1,696

)

    (92

)

Net unrealized gain (loss) recognized in comprehensive income

    1,260       191       (805

)

    3,993  

Tax effect

          (38

)

          (1,345

)

Other comprehensive income (loss)

    1,260       153       (805

)

    2,648  
                                 

Comprehensive income (loss)

  $ 184     $ (696

)

  $ (3,417

)

  $ (4,722

)

  

See accompanying notes to unaudited consolidated financial statements.

 

 

PORTER BANCORP, INC.

Unaudited Consolidated Statements of Changes in Stockholders’ Equity

For Nine Months Ended September 30,

(Dollar amounts in thousands except share and per share data)

 

   

Shares

   

Amount

         
   

Common

    Preferred            

Preferred

   

Common

         
                                                                                                                                 
   

Common

   

Non-Voting

Common

   

Total

Common

   

Series B

   

Series D

   

Series

E

   

Series

F

   

Common and Non-Voting Common

   

Series B

   

Series D

   

Series E

   

Series F

   

Additional

Paid-In

Capital

   

Retained

Deficit

   

Accumulated

Other

Compre-

hensive

Loss

   

Total

 
                                                                                                                                 

Balances, January 1, 2015

    14,890,514             14,890,514       40,536       64,580       6,198       4,304     $ 113,238     $ 2,229     $ 3,552     $ 1,644     $ 1,127     $ 21,442     $ (107,595

)

  $ (2,172

)

  $ 33,465  

Issuance of unvested stock

    915,740             915,740                                                                                

Terminated stock

    (538,479

)

          (538,479

)

                                                                             

Forfeited unvested stock

    (30,170

)

          (30,170

)

                                                                             

Stock-based compensation expense

                                                                            313                   313  

Net loss

                                                                                  (2,612

)

          (2,612

)

Net change in accumulated other

comprehensive loss, net of taxes

                                                                                        (805

)

    (805

)

Conversion of preferred stock to common and non-voting common stock

    4,053,600       6,458,000       10,511,600       (40,536

)

    (64,580

)

                5,781       (2,229

)

    (3,552

)

                                   

Debt to equity exchange

    800,000       400,000       1,200,000                               1,680                               1,767                   3,447  

Balances, September 30, 2015

    20,091,205       6,858,000       26,949,205                   6,198       4,304     $ 120,699     $     $     $ 1,644     $ 1,127     $ 23,522     $ (110,207

)

  $ (2,977

)

  $ 33,808  

 

See accompanying notes.

 

  

PORTER BANCORP, INC.

Unaudited Consolidated Statements of Cash Flows

For Nine Months Ended September 30, 2015 and 2014

(dollars in thousands)

 

   

2015

   

2014

 

Cash flows from operating activities

               

Net loss

  $ (2,612

)

  $ (7,370

)

Adjustments to reconcile net loss to net cash from operating activities

               

Depreciation and amortization

    1,201       1,329  

Provision (negative provision) for loan losses

    (2,200

)

    6,300  

Net amortization on securities

    1,084       1,219  

Stock-based compensation expense

    313       480  

Gain on extinguishment of junior subordinated debt

    (883

)

     

Tax benefit from OCI components

          (1,345

)

Net loss (gain) on sales of loans held for sale

    216       (52

)

Loans originated for sale

    (5,290

)

    (2,265

)

Proceeds from sales of loans held for sale

    5,289       2,466  

Net (gain) loss on sales of other real estate owned

    (27

)

    (455

)

Net write-down of other real estate owned

    7,080       1,250  

Net realized gain on sales of investment securities

    (1,696

)

    (92

)

Earnings on bank owned life insurance, net of premium expense

    (214

)

    (192

)

Net change in accrued interest receivable and other assets

    893       (132

)

Net change in accrued interest payable and other liabilities

    939       1,888  

Net cash from operating activities

    4,093       3,029  
                 

Cash flows from investing activities

               

Purchases of available for sale securities

    (16,800

)

    (41,156

)

Sales and calls of available for sale securities

    44,340       4,151  

Maturities and prepayments of available for sale securities

    16,408       11,295  

Proceeds from mandatory redemption of Federal Home Loan Bank stock

          2,749  

Calls of held to maturity securities

          1,000  

Proceeds from sale of other real estate owned

    14,417       7,253  

Proceeds from sales of loans not originated for sale

    8,640        

Loan originations and payments, net

    (7,029

)

    28,844  

Purchases of premises and equipment, net

    (308

)

    (416

)

Net cash from investing activities

    59,668       13,720  
                 

Cash flows from financing activities

               

Net change in deposits

    (48,948

)

    (54,173

)

Net change in repurchase agreements

    (1,341

)

    (653

)

Repayment of Federal Home Loan Bank advances

    (17,497

)

    (10,577

)

Advances from Federal Home Loan Bank

    5,000       23,025  

Repayment of subordinated capital note

    (675

)

    (675

)

Net cash from financing activities

    (63,461

)

    (43,053

)

Net change in cash and cash equivalents

    300

 

    (26,304

)

Beginning cash and cash equivalents

    80,180       111,134  

Ending cash and cash equivalents

  $ 80,480     $ 84,830  
                 

Supplemental cash flow information:

               

Interest paid

  $ 5,523     $ 7,241  

Income taxes paid (refunded)

           

Supplemental non-cash disclosure:

               

Transfer from loans to other real estate

  $ 4,450     $ 31,663  

Effect of junior subordinated debt to equity exchange

    4,330        

  

See accompanying notes to unaudited consolidated financial statements.

 

 

PORTER BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

 

 

Note 1 – Basis of Presentation and Summary of Significant Accounting Policies

 

Basis of Presentation – The consolidated financial statements include Porter Bancorp, Inc. (Company) and its subsidiary, PBI Bank (Bank).  The Company owns a 100% interest in the Bank. All significant inter-company transactions and accounts have been eliminated in consolidation.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, the financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the nine months ended September 30, 2015 are not necessarily indicative of the results that may be expected for the entire year.  A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2014 included in the Company’s Annual Report on Form 10-K.

 

Use of Estimates – To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ.

 

Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation. The reclassifications did not impact net income (loss) or stockholders’ equity.

 

Note 2 – Going Concern Considerations and Future Plans

 

The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business for the foreseeable future. However, the events and circumstances described in this Note create substantial doubt about the Company’s ability to continue as a going concern.

 

During the three and nine months ended September 30, 2015, we reported net loss attributable to common shareholders of $1.0 million and $2.3 million, respectively, compared with net loss attributable to common shareholders of $1.5 million and $8.8 million for the three and nine months ended September 30, 2014, respectively. The improvement for 2015 is primarily attributable to a negative provision for loan losses of $2.2 million in the third quarter of 2015, compared to $6.3 million of provision expense recorded in the second quarter of 2014. The $2.2 million negative provision in the third quarter was primarily driven by declining historical loss rates, improvement in asset quality, and management’s assessment of risk in the portfolio. Substandard loans decreased by $21.5 million or 31.2% over the past quarter and $44.0 million or 48% over the first nine months of 2015. Net charge-offs were $3.0 million for the first nine months of 2015 compared to $10.2 million for the first nine months of 2014, and $411,000 for the third quarter of 2015 compared to $1.8 million in the second quarter of 2015. Nonaccrual loans decreased by $13.2 million or 43.8% over the past quarter, and $30.2 million or 64.0% over the first nine months of 2015.

 

At September 30, 2015, we continued to be involved in various legal proceedings in which we dispute the material factual allegations against us. After conferring with our legal advisors, we believe we have meritorious grounds on which to prevail. If we do not prevail, the ultimate outcome of any one of these matters could have a material adverse effect on our financial condition, results of operations, or cash flows. These matters are more fully described in Note 13 – “Contingencies”.

 

For the year ended December 31, 2014, we reported a net loss of $11.2 million. This loss was attributable primarily to loan loss provision of $7.1 million, OREO expense of $5.8 million resulting from fair value write-downs driven by new appraisals and reduced marketing prices, and ongoing operating expense, along with $3.0 million in loan collection expenses. We also had lower net interest margin due to lower average loans outstanding, loans re-pricing at lower rates, and the level of non-performing loans in our portfolio. After deductions for dividends and accretion on preferred stock of $2.4 million, allocating losses to participating securities of $3.2 million, and the effect of the exchange of preferred stock for common stock of $36.1 million, net income attributable to common shareholders was $19.4 million for the year ended December 31, 2014, compared with a net loss attributable to common shareholders of $3.4 million for the year ended December 31, 2013.

 

In June 2011, the Bank agreed to a Consent Order with the FDIC and KDFI in which the Bank agreed, among other things, to improve asset quality, reduce loan concentrations, and maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. In October 2012, the Bank entered into a revised Consent Order with the FDIC and KDFI again agreeing to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Bank also agreed that if it should be unable to reach the required capital levels, and if directed in writing by the FDIC, then the Bank would within 30 days develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution or otherwise immediately obtain a sufficient capital investment into the Bank to fully meet the capital requirements. In October 2015, the Bank agreed to enter into a new revised Consent Order, which includes several of the substantive provisions of the June 2011 and October 2012 Consent Orders, but omits previous provisions related to reducing loan concentrations that the Bank had satisfied. The revised Consent Order requires the Bank to continue to adhere to the plans implemented in response to the previous Consent Orders. The revised Consent Order is included as an exhibit to this report.

 

  

We continue to work toward capital ratio compliance. As of September 30, 2015, the Bank’s Tier 1 leverage ratio and total risk based capital ratio were both less than the minimum capital ratios required by the Consent Order. Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a consent order. Based on individual circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious adverse actions such as directing a bank to seek a buyer or taking a bank into receivership.

 

In order to meet the capital requirements of the Consent Order, the Board of Directors and management are continuing to evaluate and implement strategies to achieve the following objectives:

 

 

 

Increasing capital through the limited issuance of common stock to new and existing shareholders.

 

 

Continuing to operate the Company and Bank in a safe and sound manner.  We have reduced our lending concentrations, and the size of our balance sheet while continuing to remediate non-performing loans.

 

 

In executing on our commitment to improve credit quality, reduce loan concentrations, and reduce balance sheet risk, we have:

 

 

o

Reduced the size of our loan portfolio significantly from $1.3 billion at December 31, 2010 to $624.4 million at September 30, 2015.   

 

 

o

Reduced our construction and development loans to less than 75% of total risk-based capital at September 30, 2015.

 

 

o

Reduced our non-owner occupied commercial real estate loans, construction and development loans, and multi-family residential real estate loans.  These loans represented 221% of total risk-based capital at September 30, 2015, down from 262% at December 31, 2014.

 

 

Executing on our commitment to sell OREO and reinvest in quality income producing assets.

 

 

o

Our acquisition of real estate assets through the loan remediation process increased during 2014, as we acquired $32.3 million of OREO in 2014 compared with $20.6 million during 2013. We acquired $4.5 million in the first nine months of 2015. Nonaccrual loans totaled $17.0 million at September 30, 2015, and we expect to resolve a portion of these loans by foreclosure, which may result in further additions to our OREO portfolio.

  

 

o

We incurred OREO losses totaling $7.1 million during the first nine months of 2015, the result of fair value write-downs to reflect reductions in listing prices for certain properties, updated appraisals, and the liquidation of properties through auctions near and after the end of the third quarter, offset by a $27,000 net gain on sales of OREO. Proceeds from the sale of OREO totaled $14.4 million for the nine months ended September 30, 2015, and $7.3 million for the nine months ended September 30, 2014. OREO expense may be elevated in future periods as we work to sell these properties, given the current size of the OREO portfolio. At quarter end, $6.5 million of OREO property was subject to a contract for sale or letter of intent.

  

 

o

Real estate construction represents 50% of the OREO portfolio at September 30, 2015 compared with 40% at December 31, 2014. Commercial real estate represents 41% of the OREO portfolio at September 30, 2015 compared with 31% at December 31, 2014, and 1-4 family residential properties represent 9% of the portfolio at September 30, 2015 compared with 17% at December 31, 2014.

 

 

Continuing to improve our internal processes and procedures, distribution of labor, and work-flow to ensure we have adequately and appropriately deployed resources in an efficient manner in the current environment.

 

 

The Company’s liquid assets were $1.2 million at September 30, 2015. Since the Bank is unlikely to be in a position to pay dividends to the parent company for the foreseeable future, cash inflows for the parent are limited to earnings on investment securities, sales of investment securities, interest on deposits with the Bank, the issuance of new debt, or the issuance of capital securities. Ongoing operating expenses of the parent company are forecast at approximately $1.0 million for the next twelve months.

 

  

Effective with the fourth quarter of 2011, we began deferring interest payments on the junior subordinated debentures relating to our trust preferred securities. Deferring interest payments on the junior subordinated debentures resulted in a deferral of distributions on our trust preferred securities. If we defer distributions on our trust preferred securities for 20 consecutive quarters, we must pay all deferred distributions in full or we will be in default. Our deferral period expires in the third quarter of 2016. Deferred distributions on our trust preferred securities, which totaled $2.3 million as of September 30, 2015, are cumulative, and unpaid distributions accrue and compound on each subsequent payment date. If as a result of a default we become subject to any liquidation, dissolution or winding up, holders of the trust preferred securities will be entitled to receive the liquidation amounts to which they are entitled, including all accrued and unpaid distributions, before any distribution can be made to our shareholders. In addition, the holders of our Series E and Series F Preferred Shares will be entitled to receive liquidation distributions totaling $10.5 million before any distribution can be made to the holders of our common shares.

 

On September 30, 2015, we completed a common equity for debt exchange with holders of $4.0 million of the capital securities (the “Trust Securities”) of Porter Statutory Trust IV, a trust subsidiary of the Company. Accrued and unpaid interest on the Trust Securities totaled approximately $330,000. In exchange for the $4.3 million debt and interest liability, the Company issued 800,000 common shares and 400,000 non-voting common shares, for a total of 1,200,000 shares. In the transaction, a wholly owned subsidiary of the Company received a one-third portion of the Trust Securities directly from an unrelated third party in exchange for 400,000 common shares, resulting in an $883,000 gain on extinguishment of debt. The subsidiary also received two-thirds of the Trust Securities from related parties in exchange for 400,000 common shares and 400,000 non-voting common shares. The debt and interest liability exchanged with related parties was treated as a capital transaction.

 

 

Note 3 – Securities

 

The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

  

   

Amortized

Cost

   

Gross Unrealized

Gains

   

Gross Unrealized

Losses

   

Fair

Value

 
   

(in thousands)

 

September 30, 2015

                               

Available for sale

                               

U.S. Government and federal agency

  $ 30,882     $ 212     $ (279

)

  $ 30,815  

Agency mortgage-backed: residential

    104,642       1,637       (113

)

    106,166  

State and municipal

    6,595       328       (7

)

    6,916  

Corporate bonds

    2,316       6       (33

)

    2,289  

Other debt securities

    572       79             651  

Total available for sale

  $ 145,007     $ 2,262     $ (432

)

  $ 146,837  

 

   

Amortized

Cost

   

Gross Unrecognized Gains

   

Gross Unrecognized

Losses

   

Fair

Value

 

Held to maturity

                               

State and municipal

  $ 42,138     $ 2,106     $     $ 44,244  

Total held to maturity

  $ 42,138     $ 2,106     $     $ 44,244  

 

   

Amortized

Cost

   

Gross Unrealized

Gains

   

Gross Unrealized

Losses

   

Fair

Value

 

December 31, 2014

                               

Available for sale

                               

U.S. Government and federal agency

  $ 35,725     $ 308     $ (590

)

  $ 35,443  

Agency mortgage-backed: residential

    121,985       1,970       (357

)

    123,598  

State and municipal

    11,690       722       (8

)

    12,404  

Corporate bonds

    18,087       853       (252

)

    18,688  

Other debt securities

    572       86             658  

Total available for sale

  $ 188,059     $ 3,939     $ (1,207

)

  $ 190,791  

 

   

Amortized

Cost

   

Gross Unrecognized Gains

   

Gross Unrecognized

Losses

   

Fair

Value

 

Held to maturity

                               

State and municipal

  $ 42,325     $ 2,173     $     $ 44,498  

Total held to maturity

  $ 42,325     $ 2,173     $     $ 44,498  

 

 

Sales and calls of available for sale securities were as follows:

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2015

   

2014

   

2015

   

2014

 
    (in thousands)     (in thousands)  

Proceeds

  $ 230     $ 4,147     $ 44,340     $ 4,151  

Gross gains

          86       1,832       132  

Gross losses

          40       136       40  

 

The amortized cost and fair value of the debt investment securities portfolio are shown by contractual maturity.  Contractual maturities may differ from actual maturities if issuers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities not due at a single maturity date are detailed separately. 

 

   

September 30, 2015

 
   

Amortized

Cost

   

Fair

Value

 
   

(in thousands)

 

Maturity

               

Available for sale

               

Within one year

  $ 5,821     $ 5,854  

One to five years

    8,532       8,882  

Five to ten years

    25,440       25,284  

Beyond ten years

    572       651  

Agency mortgage-backed: residential

    104,642       106,166  

Total

  $ 145,007     $ 146,837  
                 

Held to maturity

               

One to five years

  $ 15,644     $ 16,262  

Five to ten years

    22,937       24,208  

Beyond ten years

    3,557       3,774  

Total

  $ 42,138     $ 44,244  

                                                                                                 

Securities pledged at September 30, 2015 and December 31, 2014 had carrying values of approximately $51.6 million and $80.8 million, respectively, and were pledged to secure public deposits and repurchase agreements.

 

At September 30, 2015 and December 31, 2014, we held securities issued by the Commonwealth of Kentucky or municipalities in the Commonwealth of Kentucky having a book value of $17.7 million and $19.1 million, respectively.  Additionally, at September 30, 2015 and December 31, 2014, we held securities issued by the State of Texas or municipalities in the State of Texas having a book value of $4.3 million and $4.4 million, respectively.  At September 30, 2015 and December 31, 2014, there were no other holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity. 

 

 

Securities with unrealized losses at September 30, 2015 and December 31, 2014, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, are as follows:

 

   

Less than 12 Months

   

12 Months or More

   

Total

 

Description of Securities

 

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

 
   

(in thousands)

 

September 30, 2015

                                               

Available for sale

                                               

U.S. Government and federal agency

  $ 5,280     $ (12

)

  $ 14,798     $ (267

)

  $ 20,078     $ (279

)

Agency mortgage-backed: residential

    6,071       (40

)

    4,014       (73

)

    10,085       (113

)

State and municipal

    472       (7

)

                472       (7

)

Corporate bonds

    1,519       (33

)

                1,519       (33

)

Total available for sale temporarily impaired

  $ 13,342     $ (92

)

  $ 18,812     $ (340

)

  $ 32,154     $ (432

)

 

 

   

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

 
                                                 

December 31, 2014

                                               

Available for sale

                                               

U.S. Government and federal agency

  $ 7,778     $ (60

)

  $ 18,681     $ (530

)

  $ 26,459     $ (590

)

Agency mortgage-backed: residential

    6,960       (12

)

    17,938       (345

)

    24,898       (357

)

State and municipal

    569       (8

)

                569       (8

)

Corporate bonds

    4,884       (119

)

    1,660       (133

)

    6,544       (252

)

Total temporarily impaired

  $ 20,191     $ (199

)

  $ 38,279     $ (1,008

)

  $ 58,470     $ (1,207

)

 

There were no held to maturity securities in an unrecognized loss position at September 30, 2015 or December 31, 2014.

 

The Company evaluates securities for other than temporary impairment (OTTI) on a quarterly basis.  Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, underlying credit quality of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the sector or industry trends and cycles affecting the issuer, and the results of reviews of the issuer’s financial condition.  Management currently intends to hold all securities with unrealized losses until recovery, which for fixed income securities may be at maturity. As of September 30, 2015, management does not believe securities within our portfolio with unrealized losses should be classified as other than temporarily impaired. 

 

 

Note 4 – Loans

 

Loans were as follows:

 

 

 

September 30,

   

December 31,

 
   

2015

   

2014

 
   

(in thousands)

 

Commercial

  $ 84,908     $ 60,936  

Commercial Real Estate:

               

Construction

    31,484       33,173  

Farmland

    76,670       77,419  

Nonfarm nonresidential

    145,899       175,452  

Residential Real Estate:

               

Multi-family

    39,579       41,891  

1-4 Family

    204,309       197,278  

Consumer

    10,483       11,347  

Agriculture

    30,609       26,966  

Other

    473       537  

Subtotal

    624,414       624,999  

Less: Allowance for loan losses

    (14,198

)

    (19,364

)

Loans, net

  $ 610,216     $ 605,635  

 

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended September 30, 2015 and 2014:

 

    Commercial    

Commercial

Real Estate

   

Residential

Real Estate

    Consumer     Agriculture     Other     Total  
    (in thousands)  
September 30, 2015:      

Beginning balance

  $ 1,946     $ 9,213     $ 5,060     $ 226     $ 359     $ 5     $ 16,809  

Negative provision

    (180

)

    (1,334

)

    (489

)

    (73

)

    (120

)

    (4

)

    (2,200

)

Loans charged off

    (201

)

    (768

)

    (486

)

    (70

)

    (41

)

    (14

)

    (1,580

)

Recoveries

    5       905       144       98       2       15       1,169  

Ending balance

  $ 1,570     $ 8,016     $ 4,229     $ 181     $ 200     $ 2     $ 14,198  
                                                         
                                                         
                                                         

September 30, 2014:

                                                       

Beginning balance

  $ 3,115     $ 14,359     $ 6,873     $ 339     $ 435     $ 12     $ 25,133  

Provision for loan losses

    (471

)

    (336

)

    803       28       (8

)

    (16

)

 

 

Loans charged off

    (216

)

    (742

)

    (806

)

    (59

)

 

      (1

)

    (1,824

)

Recoveries

    108       458       284       23       2       14       889  

Ending balance

  $ 2,536     $ 13,739     $ 7,154     $ 331     $ 429     $ 9     $ 24,198  

  

 

The following table presents the activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2015 and 2014: 

 

   

Commercial

   

Commercial

Real Estate

   

Residential

Real Estate

   

Consumer

   

Agriculture

   

Other

   

Total

 
   

(in thousands)

 

September 30, 2015:

                                                       

Beginning balance

  $ 2,046     $ 10,931     $ 5,787     $ 274     $ 319     $ 7     $ 19,364  

Negative provision

    (207

)

    (1,657

)

    (269

)

    (51

)

    (13

)

    (3

)

    (2,200

)

Loans charged off

    (675

)

    (2,361

)

    (1,777

)

    (200

)

    (111

)

    (47

)

    (5,171

)

Recoveries

    406       1,103       488       158       5       45       2,205  

Ending balance

  $ 1,570     $ 8,016     $ 4,229     $ 181     $ 200     $ 2     $ 14,198  
                                                         
                                                         

September 30, 2014:

                                                       

Beginning balance

  $ 3,221     $ 16,414     $ 7,762     $ 416     $ 305     $ 6     $ 28,124  

Provision for loan losses

    (355

)

    4,611       1,897       19       143       (15

)

    6,300  

Loans charged off

    (670

)

    (9,110

)

    (3,162

)

    (238

)

    (30

)

    (19

)

    (13,229

)

Recoveries

    340       1,824       657       134       11       37       3,003  

Ending balance

  $ 2,536     $ 13,739     $ 7,154     $ 331     $ 429     $ 9     $ 24,198  

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of September 30, 2015:

 

   

Commercial

   

Commercial

Real Estate

   

Residential

Real Estate

   

Consumer

   

Agriculture

   

Other

   

Total

 
   

(in thousands)

 

Allowance for loan losses:

                                                       

Ending allowance balance attributable to loans:

                                                       

Individually evaluated for impairment

 

$

    $ 65     $ 404    

$

   

$

   

$

    $ 469  

Collectively evaluated for impairment

    1,570       7,951       3,825       181       200       2       13,729  

Total ending allowance balance

  $ 1,570     $ 8,016     $ 4,229     $ 181     $ 200     $ 2     $ 14,198  
                                                         
                                                         

Loans:

                                                       

Loans individually evaluated for impairment

  $ 1,330     $ 14,910     $ 18,478     $ 25     $ 152    

    $ 34,895  

Loans collectively evaluated for impairment

    83,578       239,143       225,410       10,458       30,457       473       589,519  

Total ending loans balance

  $ 84,908     $ 254,053     $ 243,888     $ 10,483     $ 30,609     $ 473     $ 624,414  

  

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of December 31, 2014:

 

   

Commercial

   

Commercial

Real Estate

   

Residential

Real Estate

   

Consumer

   

Agriculture

   

Other

   

Total

 
   

(in thousands)

 

Allowance for loan losses:

                                                       

Ending allowance balance attributable to loans:

                                                       

Individually evaluated for impairment

  $ 33     $ 491     $ 227     $ 1    

$

   

$

    $ 752  

Collectively evaluated for impairment

    2,013       10,440       5,560       273       319       7       18,612  

Total ending allowance balance

  $ 2,046     $ 10,931     $ 5,787     $ 274     $ 319     $ 7     $ 19,364  
                                                         
                                                         

Loans:

                                                       

Loans individually evaluated for impairment

  $ 2,022     $ 48,141     $ 21,384     $ 61     $ 263     $ 122     $ 71,993  

Loans collectively evaluated for impairment

    58,914       237,903       217,785       11,286       26,703       415       553,006  

Total ending loans balance

  $ 60,936     $ 286,044     $ 239,169     $ 11,347     $ 26,966     $ 537     $ 624,999  

 

 

Impaired Loans

 

Impaired loans include restructured loans and loans on nonaccrual or classified as doubtful, whereby collection of the total amount is improbable, or loss, whereby all or a portion of the loan has been written off or a specific allowance for loss has been provided.

 

The following tables present information related to loans individually evaluated for impairment by class of loans as of September 30, 2015 and December 31, 2014 and for the three and nine months ended September 30, 2015 and 2014:

 

   

As of September 30, 2015

   

Three Months Ended

September 30, 2015

   

Nine Months Ended

September 30, 2015

 
   

Unpaid

Principal

Balance

   

Recorded

Investment

   

Allowance

For Loan

Losses

Allocated

   

Average

Recorded

Investment

   

Interest

Income

Recognized

   

Average

Recorded

Investment

   

Interest

Income

Recognized

 
   

(in thousands)

 

With No Related Allowance Recorded:

                                                       

Commercial

  $ 1,774     $ 1,330     $     $ 1,439     $     $ 1,630     $ 5  

Commercial real estate:

                                                       

Construction

    803       654             833       3       2,426       11  

Farmland

    6,521       4,164             4,305       34       4,555       60  

Nonfarm nonresidential

    13,837       9,403             13,347       65       18,133       202  

Residential real estate:

                                                       

Multi-family

    32       31             33             37        

1-4 Family

    15,204       12,426             13,163       96       14,040       340  

Consumer

    123       25             23             25        

Agriculture

    260       152             191             219        

Other

                            1       61       5  

Subtotal

    38,554       28,185             33,334       199       41,126       623  

With An Allowance Recorded:

                                                       

Commercial

                      4             16        

Commercial real estate:

                                                       

Construction

                                         

Farmland

                                  79        

Nonfarm nonresidential

    788       689       65       2,708       6       5,622       18  

Residential real estate:

                                                       

Multi-family

    4,212       4,212       65       4,216       51       4,237       153  

1-4 Family

    1,809       1,809       339       1,691       29       1,709       68  

Consumer

                                  10        

Agriculture

                                         

Other

                                         

Subtotal

    6,809       6,710       469       8,619       86       11,673       239  

Total

  $ 45,363     $ 34,895     $ 469     $ 41,953     $ 285     $ 52,799     $ 862  

  

 

   

As of December 31, 2014

   

Three Months Ended

September 30, 2014

   

Nine Months Ended

September 30, 2014

 
   

Unpaid

Principal

Balance

   

Recorded

Investment

   

Allowance

For Loan

Losses

Allocated

   

Average

Recorded

Investment

   

Interest

Income

Recognized

   

Average

Recorded

Investment

   

Interest

Income

Recognized

 
   

(in thousands)

 

With No Related Allowance Recorded:

                                                       

Commercial

  $ 2,546     $ 1,978     $     $ 1,972     $     $ 2,325     $ 55  

Commercial real estate:

                                                       

Construction

    4,714       4,100             4,133       3       5,783       9  

Farmland

    6,636       4,739             5,684       26       6,503       74  

Nonfarm nonresidential

    34,437       22,418             30,395       128       44,211       586  

Residential real estate:

                                                       

Multi-family

    81       81             85             2,060        

1-4 Family

    18,496       15,266             19,987       150       24,520       567  

Consumer

    93       29             16             10        

Agriculture

    276       263             249             280       3  

Other

    367       122             169       5       288       14  

Subtotal

    67,646       48,996             62,690       312       85,980       1,308  

With An Allowance Recorded:

                                                       

Commercial

    145       44       33       161       11       1,190       31  

Commercial real estate:

                                                       

Construction

                      355       5       736       16  

Farmland

    658       315       38                   62        

Nonfarm nonresidential

    19,454       16,569       453       9,983       165       13,273       336  

Residential real estate:

                                                       

Multi-family

    4,266       4,266       91       4,274       52       4,467       128  

1-4 Family

    1,791       1,771       136       1,715       20       1,858       58  

Consumer

    32       32       1       41       1       53       2  

Agriculture

                                         

Other

                                         

Subtotal

    26,346       22,997       752       16,529       254       21,639       571  

Total

  $ 93,992     $ 71,993     $ 752     $ 79,219     $ 566     $ 107,619     $ 1,879  

 

Cash basis income recognized for the three and nine months ended September 30, 2015 was $47,000 and $149,000, respectively, compared to $58,000 and $480,000 for the three and nine months ended September 30, 2014.

 

Troubled Debt Restructuring

 

A troubled debt restructuring (TDR) occurs when the Company has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty.  The majority of the Company’s TDRs involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period.  All TDRs are considered impaired and the Company has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower.

 

The following table presents the types of TDR loan modifications by portfolio segment outstanding as of September 30, 2015 and December 31, 2014: 

 

   

TDRs

Performing to

Modified Terms

   

TDRs Not

Performing to

Modified Terms

   

Total

TDRs

 
   

(in thousands)

 

September 30, 2015

                       

Commercial

                       

Rate reduction

  $     $ 68     $ 68  

Principal deferral

          626       626  

Commercial Real Estate:

                       

Construction

                       

Rate reduction

    264             264  

Farmland

                       

Principal deferral

          2,365       2,365  

Nonfarm nonresidential

                       

Rate reduction

    5,679       75       5,754  

Principal deferral

          654       654  

Residential Real Estate:

                       

Multi-family

                       

Rate reduction

    4,212             4,212  

1-4 Family

                       

Rate reduction

    7,501             7,501  

Total TDRs

  $ 17,656     $ 3,788     $ 21,444  

  

 

   

TDRs

Performing to

Modified Terms

   

TDRs Not

Performing to

Modified Terms

   

Total

TDRs

 
   

(in thousands)

 

December 31, 2014

                       

Commercial

                       

Rate reduction

  $ 14     $     $ 14  

Principal deferral

          869       869  

Commercial Real Estate:

                       

Construction

                       

Rate reduction

    268       3,379       3,647  

Farmland

                       

Principal deferral

          2,365       2,365  

Other

                       

Rate reduction

    8,622       13,894       22,516  

Principal deferral

    671             671  

Residential Real Estate:

                       

Multi-family

                       

Rate reduction

    4,266             4,266  

1-4 Family

                       

Rate reduction

    8,112             8,112  

Consumer

                       

Rate reduction

    32             32  

Total TDRs

  $ 21,985     $ 20,507     $ 42,492  

 

At September 30, 2015 and December 31, 2014, 83% and 52%, respectively, of the Company’s TDRs were performing according to their modified terms.  The Company allocated $198,000 and $579,000 in reserves to borrowers whose loan terms have been modified in TDRs as of September 30, 2015, and December 31, 2014, respectively.  The Company has made no commitment to lend additional amounts to customers as of September 30, 2015 and December 31, 2014 to borrowers with outstanding loans classified as TDRs.

 

Management periodically reviews renewals/modifications of previously identified TDRs, for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower would continue to comply with the terms of the loan after the date of the renewal/modification. In this instance, the TDR was originally considered a restructuring in a prior year as a result of a modification with an interest rate that was not commensurate with the risk of the underlying loan. Additionally, TDR classification can be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms that were considered to be at market for loans with comparable risk. Management expects the borrower will continue to perform under the re-modified terms based on the borrower’s past history of performance.

 

No TDR loan modifications occurred during the three or nine months ended September 30, 2015 or September 30, 2014. During the first nine months of 2015 and 2014, no TDRs defaulted on their restructured loan within the 12 month period following the loan modification. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual.  

 

 

Nonperforming Loans

 

Nonperforming loans include impaired loans not on accrual and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment.

 

The following table presents the recorded investment in nonaccrual and loans past due 90 days and still on accrual by class of loan as of September 30, 2015, and December 31, 2014: 

   

Nonaccrual

   

Loans Past Due 90 Days

And Over Still Accruing

 
   

September 30,

2015

   

December 31,

2014

   

September 30,

2015

   

December 31,

2014

 
   

(in thousands)

 
                                 

Commercial

  $ 1,330     $ 1,978     $     $  

Commercial Real Estate:

                               

Construction

    390       3,831              

Farmland

    4,164       5,054              

Nonfarm nonresidential

    4,412       26,892              

Residential Real Estate:

                               

Multi-family

    32       80              

1-4 Family

    6,482       8,925             151  

Consumer

    25       30              

Agriculture

    152       263              

Other

          122              

Total

  $ 16,987     $ 47,175     $     $ 151  

 

 

The following table presents the aging of the recorded investment in past due loans as of September 30, 2015 and December 31, 2014: 

 

   

30 – 59

Days

Past Due

   

60 – 89

Days

Past Due

   

90 Days

And Over

Past Due

   

Nonaccrual

   

Total

Past Due

And

Nonaccrual

 
   

(in thousands)

 

September 30, 2015

                                       

Commercial

  $ 18     $ 4     $     $ 1,330     $ 1,352  

Commercial Real Estate:

                                       

Construction

                      390       390  

Farmland

    407       7             4,164       4,578  

Nonfarm nonresidential

          44             4,412       4,456  

Residential Real Estate:

                                       

Multi-family

                      32       32  

1-4 Family

    1,527       523             6,482       8,532  

Consumer

    14                   25       39  

Agriculture

    6                   152       158  

Total

  $ 1,972     $ 578     $     $ 16,987     $ 19,537  

  

  

   

30 – 59

Days

Past Due

   

60 – 89

Days

Past Due

   

90 Days

And Over

Past Due

   

Nonaccrual

   

Total

Past Due

And

Nonaccrual

 
   

(in thousands)

 

December 31, 2014

                                       

Commercial

  $ 86     $     $     $ 1,978     $ 2,064  

Commercial Real Estate:

                                       

Construction

                      3,831       3,831  

Farmland

    400       14             5,054       5,468  

Nonfarm nonresidential

    241       318             26,892       27,451  

Residential Real Estate:

                                       

Multi-family

                      80       80  

1-4 Family

    3,124       601       151       8,925       12,801  

Consumer

    109       47             30       186  

Agriculture

                      263       263  

Other

                      122       122  

Total

  $ 3,960     $ 980     $ 151     $ 47,175     $ 52,266  

 

Credit Quality Indicators 

 

We categorize all loans into risk categories at origination based upon original underwriting. Thereafter, we categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends.  Additionally, loans are analyzed continuously through our internal and external loan review processes. Borrower relationships in excess of $500,000 are routinely analyzed through our credit administration processes which classify the loans as to credit risk. The following definitions are used for risk ratings:

 

Watch – Loans classified as watch are those loans which have experienced a potentially adverse development which necessitates increased monitoring.

 

Special Mention – Loans classified as special mention do not have all of the characteristics of substandard or doubtful loans. They have one or more deficiencies which warrant special attention and which corrective action, such as accelerated collection practices, may remedy.

 

Substandard – Loans classified as substandard are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition which may jeopardize the repayment of the debt as contractually agreed. They are characterized by the distinct possibility we will sustain some losses if the deficiencies are not corrected.

 

Doubtful – Loans classified as doubtful are those loans which have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable. 

 

 

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be “Pass” rated loans.  As of September 30, 2015, and December 31, 2014, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows: 

 

   

Pass

   

Watch

   

Special

Mention

   

Substandard

   

Doubtful

   

Total

 
   

(in thousands)

 

September 30, 2015

                                               

Commercial

  $ 75,683     $ 3,263     $     $ 5,962     $     $ 84,908  

Commercial Real Estate:

                                               

Construction

    25,475       5,355             654             31,484  

Farmland

    65,831       4,299             6,540             76,670  

Nonfarm nonresidential

    111,725       23,161       1,339       9,674             145,899  

Residential Real Estate:

                                               

Multi-family

    30,692       4,921             3,966             39,579  

1-4 Family

    165,313       18,736       68       20,192             204,309  

Consumer

    9,759       208       293       223             10,483  

Agriculture

    23,519       6,783             307             30,609  

Other

    473                               473  

Total

  $ 508,470     $ 66,726     $ 1,700     $ 47,518     $     $ 624,414  

 

   

Pass

   

Watch

   

Special

Mention

   

Substandard

   

Doubtful

   

Total

 
   

(in thousands)

 

December 31, 2014

                                               

Commercial

  $ 49,440     $ 5,063     $     $ 6,433     $     $ 60,936  

Commercial Real Estate:

                                               

Construction

    25,266       2,990             4,917             33,173  

Farmland

    61,672       7,922             7,825             77,419  

Nonfarm nonresidential

    111,426       21,017       3,747       39,262             175,452  

Residential Real Estate:

                                               

Multi-family

    31,526       6,039             4,326             41,891  

1-4 Family

    145,450       23,928       131       27,769             197,278  

Consumer

    10,115       537       311       384             11,347  

Agriculture

    25,816       704             446             26,966  

Other

    415                   122             537  

Total

  $ 461,126     $ 68,200     $ 4,189     $ 91,484     $     $ 624,999  

 

Note 5 – Other Real Estate Owned

 

Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure.  It is classified as real estate owned until such time as it is sold.  When property is acquired as a result of foreclosure or by deed in lieu of foreclosure, it is recorded at its fair market value less cost to sell.  Any write-down of the property at the time of acquisition is charged to the allowance for loan losses.  Costs incurred in order to perfect the lien prior to foreclosure may be capitalized if the fair value less the cost to sell exceeds the balance of the loan at the time of transfer to OREO. Examples of eligible costs to be capitalized are payments of delinquent property taxes to clear tax liens or payments to contractors and subcontractors to clear mechanics’ liens.

 

Fair value of OREO is determined on an individual property basis. To determine the fair value of OREO for smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers.  If the internally evaluated market price is below our underlying investment in the property, appropriate write-downs are taken. For larger dollar residential and commercial real estate properties, we obtain a new appraisal of the subject property or have staff from our special assets group or in our centralized appraisal department evaluate the latest in-file appraisal in connection with the transfer to other real estate owned.  We typically obtain updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. Subsequent reductions in fair value are recorded as non-interest expense when a new appraisal indicates a decline in value or in cases where a listing price is lowered below the appraised amount.  

 

 

The following table presents the major categories of OREO at the period-ends indicated:

 

   

September 30,

2015

   

December 31,

2014

 
   

(in thousands)

 

Commercial Real Estate:

               

Construction, land development, and other land

  $ 14,749     $ 18,748  

Farmland

    34       669  

Nonfarm nonresidential

    12,059       14,860  

Residential Real Estate:

               

Multi-family

          4,988  

1-4 Family

    2,635       7,998  
      29,477       47,263  

Valuation allowance

    (300

)

    (1,066

)

    $ 29,177     $ 46,197  

 

   

For the Three

Months Ended

September 30,

   

For the Nine

Months Ended

September 30,

 
   

2015

   

2014

   

2015

   

2014

 
    (in thousands)     (in thousands)  

OREO Valuation Allowance Activity:

                               

Beginning balance

  $ 307     $ 199     $ 1,066     $ 230  

Provision to allowance

    4,450       600       7,080       1,250  

Write-downs

    (4,457

)

    (268

)

    (7,846

)

    (949

)

Ending balance

  $ 300     $ 531     $ 300     $ 531  

 

Residential loans secured by 1-4 family residential properties in the process of foreclosure totaled $1.6 million and $3.6 million at September 30, 2015 and December 31, 2014, respectively. At quarter end, $6.5 million of OREO property was subject to a contract for sale or letter of intent.

 

Net activity relating to other real estate owned during the nine months ended September 30, 2015 and 2014 is as follows:

 

   

For the Nine

Months Ended

September 30,

 
   

2015

   

2014

 
   

(in thousands)

 

OREO Activity

               

OREO as of January 1

  $ 46,197     $ 30,892  

Real estate acquired

    4,450       31,663  

Valuation adjustment writedowns

    (7,080

)

    (1,250

)

Gain/(loss) on sale

    27       455  

Proceeds from sale of properties

    (14,417

)

    (7,253

)

OREO as of September 30

  $ 29,177     $ 54,507  

 

Expenses related to other real estate owned include:

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2015

   

2014

   

2015

   

2014

 
    (in thousands)     (in thousands)  

Net (gain) loss on sales

  $ 16     $ (401

)

  $ (27

)

  $ (455

)

Provision to allowance

    4,450       600       7,080       1,250  

Operating expense

    665       361       1,743       1,201  

Total

  $ 5,131     $ 560     $ 8,796     $ 1,996  

 

 

Note 6 – Deposits

 

 The following table shows ending deposit balances by category as of: 

 

   

September 30,

2015

   

December 31,

2014

 
   

(in thousands)

 

Non-interest bearing

  $ 106,160     $ 114,910  

Interest checking

    83,247       91,086  

Money market

    119,324       109,734  

Savings

    35,131       36,430  

Certificates of deposit

    534,031       574,681  

Total

  $ 877,893     $ 926,841  

 

Time deposits of $250,000 or more were $33.0 million and $34.4 million at September 30, 2015 and December 31, 2014, respectively.

 

Scheduled maturities of all time deposits at September 30, 2015 were as follows (in thousands):

 

Year 1

  $ 330,881  

Year 2

    122,321  

Year 3

    9,500  

Year 4

    21,319  

Year 5

    50,010  

Thereafter

     
    $ 534,031  

 

 

Note 7 – Advances from the Federal Home Loan Bank

 

Advances from the Federal Home Loan Bank were as follows:

 

   

September 30,

   

December 31,

 
   

2015

   

2014

 
   

(in thousands)

 

Monthly amortizing advances with fixed rates from 0.00% to 5.25% and maturities ranging from 2017 through 2033, averaging 2.73% at September 30, 2015 and 1.02% at December 31, 2014

  $ 3,255     $ 15,752  

 

Each advance is payable based upon the terms on agreement, with a prepayment penalty.  New advances are limited to a one year maturity or less. No prepayment penalties were incurred during 2015 or 2014. The advances are collateralized by first mortgage loans.  The borrowing capacity is based on the market value of the underlying pledged loans. At September 30, 2015, our additional borrowing capacity with the FHLB was $25.7 million. The availability of our borrowing capacity could be affected by our financial condition and the FHLB could require additional collateral or, among other things, exercise its right to deny a funding request, at its discretion.

 

 

Note 8 – Fair Values Measurement

 

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We use various valuation techniques to determine fair value, including market, income and cost approaches.  There are three levels of inputs that may be used to measure fair values:

 

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets an entity has the ability to access as of the measurement date, or observable inputs.

 

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

 

Level 3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy.  When that occurs, we classify the fair value hierarchy on the lowest level of input that is significant to the fair value measurement.  We used the following methods and significant assumptions to estimate fair value.

 

Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities where quoted prices are not available, fair values are calculated on market prices of similar securities, or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Matrix pricing relies on the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking of like securities. Matrix pricing utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market participants. This valuation method is classified as Level 2 in the fair value hierarchy. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators. This valuation method is classified as Level 3 in the fair value hierarchy. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

 

Impaired Loans: An impaired loan is evaluated at the time the loan is identified as impaired and is recorded at fair value less costs to sell. Fair value is measured based on the value of the collateral securing the loan and is classified as Level 3 in the fair value hierarchy. Fair value is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.

 

Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

 

We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our impaired loans. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in addition to estimated discounts for cost to sell of six to ten percent.

 

We also apply discounts to the expected fair value of collateral for impaired loans where the likely resolution involves litigation or foreclosure. Resolution of this nature generally results in receiving lower values for real estate collateral in a more aggressive sales environment. We have utilized discounts ranging from 10% to 33% in our impairment evaluations when applicable.

 

  

Impaired loans are evaluated quarterly for additional impairment. We obtain updated appraisals on properties securing our loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. This determination is made on a property-by-property basis in light of circumstances in the broader economic climate and our assessment of deterioration of real estate values in the market in which the property is located. The first stage of our assessment involves management’s inspection of the property in question. Management also engages in conversations with local real estate professionals, investors, and market participants to determine the likely marketing time and value range for the property. The second stage involves an assessment of current trends in the regional market. After thorough consideration of these factors, management will either internally evaluate fair value or order a new appraisal.

 

Other Real Estate Owned (OREO): OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal evaluation less cost to sell. Our quarterly evaluations of OREO for impairment are driven by property type. For smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. Based on these consultations, we determine asking prices for OREO properties we are marketing for sale. If the internally evaluated fair value or asking price is below our recorded investment in the property, appropriate write-downs are taken.

 

For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property or have staff in our special assets group or centralized appraisal department evaluate the latest in-file appraisal in connection with the transfer to other real estate owned. In some of these circumstances, an appraisal is in process at quarter end, and we must make our best estimate of the fair value of the underlying collateral based on our internal evaluation of the property, review of the most recent appraisal, and discussions with the currently engaged appraiser. We generally obtain updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. When an asking price is lowered below the most recent appraised value, appropriate write-downs are taken.

 

We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our OREO. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in addition to estimated discounts for cost to sell of six to ten percent.

 

Financial assets measured at fair value on a recurring basis at September 30, 2015 and December 31, 2014 are summarized below:

 

           

Fair Value Measurements at September 30, 2015 Using

 
           

(in thousands)

 

Description

 

Carrying

Value

   

Quoted Prices In Active Markets for Identical Assets (Level 1)

   

Significant Other Observable Inputs (Level 2)

   

Significant Unobservable

Inputs

(Level 3)

 

Available for sale securities

                               

U.S. Government and federal agency

  $ 30,815     $     $ 30,815     $  

Agency mortgage-backed: residential

    106,166             106,166        

State and municipal

    6,916             6,916        

Corporate bonds

    2,289             2,289        

Other debt securities

    651                   651  

Total

  $ 146,837     $     $ 146,186     $ 651  

 

 

           

Fair Value Measurements at December 31, 2014 Using

 
           

(in thousands)

 

Description

 

Carrying

Value

   

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

   

Significant Other

Observable Inputs

(Level 2)

   

Significant

Unobservable

Inputs

(Level 3)

 

Available for sale securities

                               

U.S. Government and federal agency

  $ 35,443     $     $ 35,443     $  

Agency mortgage-backed: residential

    123,598             123,598        

State and municipal

    12,404             12,404        

Corporate bonds

    18,688             18,688        

Other debt securities

    658                   658  

Total

  $ 190,791     $     $ 190,133     $ 658  

  

 

There were no transfers between Level 1 and Level 2 during 2015 or 2014.

 

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods ended September 30, 2015 and 2014:

 

   

Other Debt

Securities

 
   

2015

   

2014

 
   

(in thousands)

 

Balances of recurring Level 3 assets at January 1

  $ 658     $ 632  

Total gain (loss) for the period:

               

Included in other comprehensive income (loss)

    (7

)

    26  

Balance of recurring Level 3 assets at September 30

  $ 651     $ 658  

 

Our other debt security valuation is determined internally by calculating discounted cash flows using the security’s coupon rate of 6.5% and an estimated current market rate of 8.25% based upon the current yield curve plus spreads that adjust for volatility, credit risk, and optionality.  We also consider the issuer’s publicly filed financial information as well as assumptions regarding the likelihood of deferrals and defaults.

 

Financial assets measured at fair value on a non-recurring basis are summarized below: 

 

           

Fair Value Measurements at September 30, 2015 Using

 
           

(in thousands)

 
       

Carrying

Value

   

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

   

Significant Other

Observable Inputs

(Level 2)

   

Significant

Unobservable

Inputs

(Level 3)

 

Description

                               

Impaired loans:

                               

Commercial

  $     $     $     $  

Commercial real estate:

                               

Construction

                       

Farmland

                       

Nonfarm nonresidential

    339                   339  

Residential real estate:

                               

Multi-family

                       

1-4 Family

    1,470                   1,470  

Consumer

                       

Other

                       

Other real estate owned, net:

                               

Commercial real estate:

                               

Construction

    14,599                   14,599  

Farmland

    33                   33  

Nonfarm nonresidential

    11,937                   11,937  

Residential real estate:

                               

Multi-family

                       

1-4 Family

    2,608                   2,608  

 

           

Fair Value Measurements at December 31, 2014 Using

 
           

(in thousands)

 
   

Carrying

Value

   

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

   

Significant Other

Observable Inputs

(Level 2)

   

Significant

Unobservable

Inputs

(Level 3)

 

Description

                               

Impaired loans:

                               

Commercial

  $ 12     $     $     $ 12  

Commercial real estate:

                               

Construction

                       

Farmland

    278                   278  

Other

    15,825                   15,825  

Residential real estate:

                               

Multi-family

                       

1-4 Family

    1,635                   1,635  

Consumer

    31                   31  

Other

                       

Other real estate owned, net:

                               

Commercial real estate:

                               

Construction

    18,325                   18,325  

Farmland

    654                   654  

Other

    14,525                   14,525  

Residential real estate:

                               

Multi-family

    4,875                   4,875  

1-4 Family

    7,818                   7,818  

  

 

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $2.2 million at September 30, 2015 with a valuation allowance of $369,000, resulting in no additional provision for loan losses for the three and nine months ended September 30, 2015. Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $8.9 million at September 30, 2014 with a valuation allowance of $1.7 million, resulting in an additional provision for loan losses of $5.2 million for the nine months ended September 30, 2014. At December 31, 2014, impaired loans had a carrying amount of $18.4 million, with a valuation allowance of $622,000.

 

OREO, which is measured at the lower of carrying or fair value less estimated costs to sell, had a net carrying amount of $29.2 million as of September 30, 2015, compared with $54.5 million at September 30, 2014 and $46.2 million at December 31, 2014.  Fair value write-downs of $7.1 million and $1.3 million were recorded on OREO for the nine months ended September 30, 2015 and 2014, respectively.

 

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2015: 

 

   

Fair Value

 

Valuation

Technique(s)

 

Unobservable Input(s)

 

Range (Weighted

Average)

   

(in thousands)

               
                       

Impaired loans – Commercial real estate

  $ 339  

Sales comparison approach

 

Adjustment for differences between the comparable sales

   5% - 16%(11%)
                       
          Income approach   Discount or capitalization rate   9% - 10%(9%)
                       

Impaired loans – Residential real estate

  $ 1,470  

Sales comparison approach

 

Adjustment for differences between the comparable sales

   1% - 16%(7%)
                       

Other real estate owned – Commercial real estate

  $ 26,569  

Sales comparison approach

 

Adjustment for differences between the comparable sales

   0% - 72%(21%)
                       
          Income approach   Discount or capitalization rate   9% - 20%(13%)
                       

Other real estate owned – Residential real estate

  $ 2,608  

Sales comparison approach

 

Adjustment for differences between the comparable sales

   0% - 15%(8%)

  

 

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2014:

 

   

Fair Value

 

Valuation

Technique(s)

 

Unobservable Input(s)

 

Range (Weighted

Average)

   

(in thousands)

               
                       

Impaired loans – Commercial

  $ 12  

Market value approach

 

Adjustment for receivables and inventory discounts

   16% - 32%(24%)
                       

Impaired loans – Commercial real estate

  $ 16,103  

Sales comparison approach

 

Adjustment for differences between the comparable sales

   0% - 62%(14%)
                       
          Income approach   Discount or capitalization rate   8% - 9%(8%)
                       

Impaired loans – Residential real estate

  $ 1,635  

Sales comparison approach

 

Adjustment for differences between the comparable sales

   0% 39%(11%)
                       

Other real estate owned – Commercial real estate

  $ 33,504  

Sales comparison approach

 

Adjustment for differences between the comparable sales

   0% 45%(18%)
                       
          Income approach   Discount or capitalization rate   9% - 20%(13%)
                       

Other real estate owned – Residential real estate

  $ 12,693  

Sales comparison approach

 

Adjustment for differences between the comparable sales

   0% 15%(6%)

 

Carrying amount and estimated fair values of financial instruments were as follows for the periods indicated:

 

           

Fair Value Measurements at September 30, 2015 Using

 
   

Carrying

Amount

   

Level 1

   

Level 2

   

Level 3

   

Total

 
   

(in thousands)

 

Financial assets

                                       

Cash and cash equivalents

  $ 80,480     $ 68,257     $ 12,223     $     $ 80,480  

Securities available for sale

    146,837             146,186       651       146,837  

Securities held to maturity

    42,138             44,244             44,244  

Federal Home Loan Bank stock

    7,323       N/A       N/A       N/A       N/A  

Loans held for sale

    71             71             71  

Loans, net

    610,216                   620,807       620,807  

Accrued interest receivable

    3,291             1,052       2,239       3,291  

Financial liabilities

                                       

Deposits

  $ 877,893     $ 106,160     $ 766,831     $     $ 872,991  

Securities sold under agreements to repurchase

                             

Federal Home Loan Bank advances

    3,255             3,263             3,263  

Subordinated capital notes

    4,275                   4,142       4,142  

Junior subordinated debentures

    21,000                   12,638       12,638  

Accrued interest payable

    2,851             530       2,321       2,851  

  

  

           

Fair Value Measurements at December 31, 2014 Using

 
   

Carrying

Amount

   

Level 1

   

Level 2

   

Level 3

   

Total

 
   

(in thousands)

 

Financial assets

                                       

Cash and cash equivalents

  $ 80,180     $ 49,007     $ 31,173     $     $ 80,180  

Securities available for sale

    190,791             190,133       658       190,791  

Securities held to maturity

    42,325             44,498             44,498  

Federal Home Loan Bank stock

    7,323       N/A       N/A       N/A       N/A  

Loans held for sale

    8,926             8,926             8,926  

Loans, net

    605,635                   615,914       615,914  

Accrued interest receivable

    3,503             1,389       2,114       3,503  

Financial liabilities

                                       

Deposits

  $ 926,841     $ 114,910     $ 804,508     $     $ 919,418  

Securities sold under agreements to repurchase

    1,341             1,341             1,341  

Federal Home Loan Bank advances

    15,752             15,758             15,758  

Subordinated capital notes

    4,950                   4,765       4,765  

Junior subordinated debentures

    25,000                   14,214       14,214  

Accrued interest payable

    2,858             751       2,107       2,858  

 

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

 

(a) Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. Non-interest bearing deposits are Level 1 whereas interest bearing due from bank accounts and fed funds sold are Level 2.

 

(b) FHLB Stock

It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

 

(c) Loans, Net

Fair values of loans, excluding loans held for sale, are estimated as follows:  For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification.  Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

 

(d) Loans Held for Sale

The fair value of loans held for sale is estimated based upon binding contracts and and/or quotes from third party investors resulting in a Level 2 classification.

 

(e) Deposits

The fair values disclosed for non-interest bearing deposits are, by definition, equal to the amount payable on demand at the reporting date resulting in a Level 1 classification. The carrying amounts of variable rate interest bearing deposits approximate their fair values at the reporting date resulting in a Level 2 classification.  Fair values for fixed rate interest bearing deposits are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

 

(f) Securities Sold Under Agreements to Repurchase

The carrying amounts of borrowings under repurchase agreements approximate their fair values resulting in a Level 2 classification.

 

(g) Other Borrowings

The fair values of the Company’s FHLB advances are estimated using discounted cash flow analyses based on the current borrowing rates resulting in a Level 2 classification.

 

The fair values of the Company’s subordinated capital notes and junior subordinated debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

 

(h) Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification based on the level of the asset or liability with which the accrual is associated.

 

 

Note 9 – Income Taxes

 

Deferred tax assets and liabilities were due to the following as of:

 

   

September 30,

   

December 31,

 
   

2015

   

2014

 
   

(in thousands)

 

Deferred tax assets:

               

Net operating loss carry-forward

  $ 35,788     $ 32,111  

Allowance for loan losses

    4,969       6,777  

Other real estate owned write-down

    9,647       10,000  

Alternative minimum tax credit carry-forward

    692       692  

Net assets from acquisitions

    671       668  

Other than temporary impairment on securities

    46       46  

New market tax credit carry-forward

    208       208  

Nonaccrual loan interest

    607       958  

Amortization of non-compete agreements

    12       14  

Other

    1,674       1,701  
      54,314       53,175  
                 

Deferred tax liabilities:

               

FHLB stock dividends

    928       928  

Fixed assets

    225       264  

Originated mortgage servicing rights

    37       53  

Net unrealized gain on securities

    297       579  

Other

    669       703  
      2,156       2,527  

Net deferred tax assets before valuation allowance

    52,158       50,648  

Valuation allowance

    (52,158

)

    (50,648

)

Net deferred tax asset

  $     $  

 

Our estimate of the realizability of the deferred tax asset is dependent on our estimate of projected future levels of taxable income. In analyzing future taxable income levels, we considered all evidence currently available, both positive and negative. Based on our analysis, we established a valuation allowance for all deferred tax assets as of December 31, 2011. The valuation allowance remains in effect as of September 30, 2015.

 

The calculation for the income tax provision or benefit generally does not consider the tax effects of changes in other comprehensive income, or OCI, which is a component of stockholders’ equity on the balance sheet. However, an exception is provided in certain circumstances, such as when there is a full valuation allowance against net deferred tax assets, there is a loss from continuing operations and there is income in other components of the financial statements. In such a case, pre-tax income from other categories, such as changes in OCI, must be considered in determining a tax benefit to be allocated to the loss from continuing operations. No tax benefit or expense was recognized for the nine months ended September 30, 2015, and a tax benefit of $1.3 million was allocated to continuing operations for the nine months ended September 30, 2014. The September 30, 2014 tax benefit is entirely due to gains in other comprehensive income that are presented in current operations in accordance with applicable accounting standards.

 

The Company does not have any beginning and ending unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. There were no interest and penalties recorded in the income statement or accrued for the nine months ended September 30, 2015 or September 30, 2014 related to unrecognized tax benefits. On June 24, 2015, the Board of Directors approved the adoption of a tax benefits preservation plan designed to preserve the value of certain of the Company's deferred tax assets primarily associated with net operating loss carryforwards (“NOLs”) under Section 382 of the Internal Revenue Code, as amended (“Section 382”). NOLs can generally be used to offset future taxable income and therefore reduce federal income tax obligations. However, the Company's ability to use its NOLs would be limited if there was an “ownership change” under Section 382. This would occur if shareholders owning (or deemed to own under the tax rules) 5% or more of the Company's increase their aggregate ownership of the Company by more than 50 percentage points over a defined period of time. The plan is intended to reduce the likelihood of an “ownership change” occurring as a result of the buying and selling of the Company's common stock.

 

In connection with the tax benefits preservation plan, the Company declared a dividend of one preferred stock purchase right for each share of common stock outstanding as of the close of business on July 10, 2015. Any shareholder or group that acquires beneficial ownership of 5% or more of the Company (an “acquiring person”) could be subject to significant dilution in its holdings if the Company's Board of Directors does not approve such acquisition. Existing shareholders holding 5% or more of the Company will not be considered acquiring persons unless they acquire additional shares, subject to certain exceptions described in the plan. In addition, in its discretion, the Board of Directors may exempt certain transactions and certain persons whose acquisition of securities is determined by the board not to jeopardize the Company's deferred tax assets.

 

  

The rights will expire upon the earlier of (i) June 29, 2018, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefits may be carried forward, (iii) the repeal or amendment of Section 382 or any successor statute, if the Board of Directors determines that the plan is no longer needed to preserve the tax benefits, and (iv) certain other events as described in the plan.

 

On September 23, 2015, the Company’s shareholders approved an amendment to its articles of incorporation to further help protect the long-term value of the Company’s NOLs. The amendment provides a means to block transfers of our common shares that could result in an ownership change under Section 382. The transfer restrictions will expire on the earlier of (i) September 23, 2018, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefit may be carried forward, (iii) the repeal of Section 382 or any successor statute if our Board determines that the transfer restrictions are no longer needed to preserve the tax benefits of our NOLs, or (iv) such date as the Board otherwise determines that the transfer restrictions are no longer necessary.

 

The Company and its subsidiaries are subject to U.S. federal income tax and the Company is subject to income tax in the Commonwealth of Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2011.

 

Note 10 – Stock Plans and Stock Based Compensation

 

The Company has two stock incentive plans. The Porter Bancorp, Inc. 2006 Stock Incentive Plan permits the issuance of up to 1,563,050 shares of the Company’s common stock upon the grant of stock awards.  As of September 30, 2015, the Company had issued and outstanding 924,091 unvested shares net of forfeitures and vesting under the stock incentive plan. Shares issued under the plan vest annually on the anniversary date of the grant over three to ten years. The Company has 301,920 shares remaining available for issuance under the plan.  

 

The Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan permits the issuance of up to 700,000 shares of the Company’s voting common stock upon the grant of stock awards. The Plan awards restricted shares having a fair market value of $25,000 annually to each non-employee director. Unvested shares are granted automatically under the plan at fair market value on the date of grant and vest on December 31 in the year of grant. The Company has issued and outstanding 115,740 unvested shares, net of forfeitures and vesting, to non-employee directors. At September 30, 2015, 185,774 shares remain available for issuance under this plan.

 

Upon the sale of our Series A preferred shares by the U.S. Treasury at a discount to face amount on December 4, 2014, the restricted shares previously granted in the employment agreements of our senior executives became subject to permanent transfer restrictions.  On March 25, 2015, the Compensation Committee modified the equity compensation arrangements with our four named executive officers to restore the incentive that was the underlying purpose of the previous grants. The Compensation Committee and the named executive officers mutually agreed to terminate 538,479 restricted shares that were subject to permanent restrictions on transfer.  We then awarded 800,000 new service-based restricted shares to our named executive officers. The new awards were accounted for as a modification and vest over four years, with one-third of the shares vesting on each of the second, third and fourth anniversaries of the date of grant.  The modification resulted in incremental compensation expense of approximately $233,000 and will be amortized in accordance with the vesting schedule.

 

The fair value of the 2015 unvested shares issued to employees was $712,000, or $0.89 per weighted-average share. The fair value of the 2015 unvested shares issued to directors was $125,000, or $1.08 per weighted-average share. The Company recorded $313,000 and $480,000 of stock-based compensation during the first nine months of 2015 and 2014, respectively, to salaries and employee benefits. We expect substantially all of the unvested shares outstanding at the end of the period to vest according to the vesting schedule. No deferred tax benefit was recognized related to this expense for either period. 

 

 

The following table summarizes unvested share activity as of and for the periods indicated for the Stock Incentive Plan:

 

   

Nine Months Ended

   

Twelve Months Ended

 
   

September 30, 2015

   

December 31, 2014

 
           

Weighted

           

Weighted

 
           

Average

           

Average

 
           

Grant

           

Grant

 
   

Shares

   

Price

   

Shares

   

Price

 

Outstanding, beginning

    770,440     $ 1.33       787,426     $ 1.56  

Granted

    800,000       0.89       122,220       0.93  

Vested

    (165,185

)

    1.50       (133,227

)

    2.20  

Terminated

    (450,994

)

    1.25              

Forfeited

    (30,170

)

    1.12       (5,979

)

    4.21  

Outstanding, ending

    924,091     $ 0.96       770,440     $ 1.33  

 

The following table summarizes unvested share activity as of and for the periods indicated for the Non-Employee Directors Stock Ownership Incentive Plan:

 

   

Nine Months Ended

   

Twelve Months Ended

 
   

September 30, 2015

   

December 31, 2014

 
           

Weighted

           

Weighted

 
           

Average

           

Average

 
           

Grant

           

Grant

 
   

Shares

   

Price

   

Shares

   

Price

 

Outstanding, beginning

    5,052     $ 1.65       47,428     $ 1.69  

Granted

    115,740       1.08       166,668       0.90  

Vested

    (5,052

)

    1.65       (154,222

)

    0.98  

Forfeited

                (54,822

)

    1.29  

Outstanding, ending

    115,740     $ 1.08       5,052     $ 1.65  

 

Unrecognized stock based compensation expense related to unvested shares for the remainder of 2015 and beyond is estimated as follows (in thousands):

 

October 2015 – December 2015

  $ 132  

2016

    253  

2017

    156  

2018

    149  

2019 & thereafter

     

 

 

Note 11 – Earnings (Loss) per Share

 

The factors used in the basic and diluted loss per share computations follow:

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 30,

   

September 30,

 
   

2015

   

2014

   

2015

   

2014

 
   

(in thousands, except share and per share data)

 
                                 

Net loss

  $ (1,076

)

  $ (849

)

  $ (2,612

)

  $ (7,370

)

Less:

                               

Preferred stock dividends

          786             2,361  

Losses allocated to unvested shares

    (45

)

    (122

)

    (102

)

    (685

)

Losses allocated to preferred

          (40

)

    (236

)

    (243

)

Net loss attributable to common shareholders, basic and diluted

  $ (1,031

)

  $ (1,473

)

  $ (2,274

)

  $ (8,803

)

                                 

Basic

                               

Weighted average common shares including unvested common shares outstanding

    25,768,887       13,435,788       25,626,610       13,314,138  

Less:

                               

Weighted average unvested common shares

    1,087,340       1,016,051       1,002,867       936,386  

Weighted average Series B preferred

                890,901        

Weighted average Series C preferred

          332,894             332,894  

Weighted average Series D preferred

                1,419,341        

Weighted average common shares outstanding

    24,681,547       12,086,843       22,313,501       12,044,858  

Basic loss per common share

  $ (0.04

)

  $ (0.12

)

  $ (0.10

)

  $ (0.73

)

                                 

Diluted

                               

Add: Dilutive effects of assumed exercises of common and Preferred Series C stock warrants

                       

Weighted average common shares and potential common shares

    24,681,547       12,086,843       22,313,501       12,044,858  

Diluted loss per common share

  $ (0.04

)

  $ (0.12

)

  $ (0.10

)

  $ (0.73

)

 

The Company had no outstanding stock options at September 30, 2015 or 2014.  A warrant for the purchase of 330,561 shares of the Company’s common stock at an exercise price of $15.88 was outstanding at September 30, 2015 and 2014 but was not included in the diluted EPS computation as inclusion would have been anti-dilutive. Additionally, warrants for the purchase of 1,449,459 shares of non-voting common stock at an exercise price of $10.95 per share were outstanding at September 30, 2014 but were not included in the diluted EPS computation as inclusion would have been anti-dilutive. A total of 798,915 warrants were cancelled in December 2014 in a non-cash equity exchange and 650,544 warrants expired in September 2015.

 

Note 12 – Capital Requirements and Restrictions on Retained Earnings

 

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.

 

The Basel III regulatory capital reforms became effective for the Company and Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios.  These rules refine the definition of what constitutes “capital” for purposes of calculating those ratios, including the definitions of Tier 1 capital and Tier 2 capital. The final rules allowed banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company and the Bank opted out of this requirement.

 

In its Consent Orders with the FDIC and the Kentucky Department of Financial Institutions, the Bank has agreed to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Consent orders are described in greater detail in Note 2 – “Going Concern and Future Plans”. As of September 30, 2015, the Bank’s Tier 1 leverage ratio and total risk based capital ratio were both less than the minimum capital ratios required by the Consent Order. The Bank cannot be considered well-capitalized while subject to the Consent Order. We are also restricted from accepting, renewing, or rolling-over brokered deposits without the prior receipt of a waiver on a case-by-case basis from our regulators.

 

 

On September 21, 2011, we entered into a Written Agreement with the Federal Reserve Bank of St. Louis in which we made formal commitments to use our financial and management resources to serve as a source of strength for the Bank and to assist the Bank in addressing weaknesses identified by the FDIC and the KDFI, to pay no dividends without prior written approval, to pay no interest or principal on subordinated debentures or trust preferred securities without prior written approval, and to submit an acceptable plan to maintain sufficient capital.

 

On September 30, 2015, we completed a common equity for debt exchange with holders of $4.0 million of the capital securities (the “Trust Securities”) of Porter Statutory Trust IV, a trust subsidiary of the Company. Accrued and unpaid interest on the Trust Securities totaled approximately $330,000. In exchange for the $4.3 million debt and interest liability, the Company issued 800,000 common shares and 400,000 non-voting common shares, for a total of 1,200,000 shares. In the transaction, a wholly owned subsidiary of the Company received a one-third portion of the Trust Securities directly from an unrelated third party in exchange for 400,000 common shares, resulting in an $883,000 gain on extinguishment of debt. The subsidiary also acquired two-thirds of the Trust Securities from related parties in exchange for 400,000 common shares and 400,000 non-voting common shares. The debt and interest liability exchanged with related parties was treated as a capital transaction.

 

The following table shows the ratios and amounts of Common Equity Tier 1, Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for Porter Bancorp, Inc. and the Bank at the dates indicated (dollars in thousands):

 

   

Actual

   

For Capital Adequacy Purposes

 
   

Amount

   

Ratio

   

Amount

   

Ratio

 

As of September 30, 2015:

                               

Total risk-based capital (to risk-weighted assets)

                               

Consolidated

  $ 69,354       10.40

%

  $ 53,324       8.00

%

Bank

    69,810       10.50       53,178       8.00  

Total common equity Tier I risk-based capital (to risk-weighted assets)

                               

Consolidated

    33,804       5.07       29,995       4.50  

Bank

    58,053       8.73       29,913       4.50  

Tier I capital (to risk-weighted assets)

                               

Consolidated

    45,719       6.86       39,993       6.00  

Bank

    58,053       8.73       39,883       6.00  

Tier I capital (to average assets)

                               

Consolidated

    45,719       4.73       38,676       4.00  

Bank

    58,053       6.01       38,625       4.00  

 

   

Actual

   

For Capital Adequacy Purposes

 
   

Amount

   

Ratio

   

Amount

   

Ratio

 

As of December 31, 2014:

                               

Total risk-based capital (to risk-weighted assets)

                               

Consolidated

  $ 73,595       10.61

%

  $ 55,483       8.00

%

Bank

    73,174       10.57       55,383       8.00  

Tier I capital (to risk-weighted assets)

                               

Consolidated

    46,459       6.70       27,741       4.00  

Bank

    59,438       8.59       27,691       4.00  

Tier I capital (to average assets)

                               

Consolidated

    46,459       4.51       41,193       4.00  

Bank

    59,438       5.78       41,143       4.00  

 

The Consent Order requires the Bank to achieve the minimum capital ratios presented below:

 

   

Actual as of September 30, 2015

   

Ratio Required by Consent Order

 
   

Amount

   

Ratio

   

Amount

   

Ratio

 
                                 

Total capital to risk-weighted assets

  $ 69,810       10.50

%

  $ 79,767       12.00

%

Tier I capital to average assets

    58,053       6.01       86,906       9.00  

  

 

At September 30, 2015, the Bank’s Tier 1 leverage ratio was 6.01%, and its total risk-based capital ratio was 10.50%, which are below the 9% and 12% minimum capital ratios required by the Consent Order. Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a Consent Order. Based on individual circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious adverse actions.

 

Kentucky banking laws limit the amount of dividends that may be paid to a holding company by its subsidiary banks without prior approval. These laws limit the amount of dividends that may be paid in any calendar year to current year’s net income, as defined in the laws, combined with the retained net income of the preceding two years, less any dividends declared during those periods. The Bank has agreed with its primary regulators to obtain their written consent prior to declaring or paying any future dividends. As a practical matter, the Bank cannot pay dividends to the Company for the foreseeable future.

 

 

Note 13 – Contingencies

 

We are defendants in various legal proceedings. Litigation is subject to inherent uncertainties and unfavorable rulings could occur. We record contingent liabilities resulting from claims against us when a loss is assessed to be probable and the amount of the loss is reasonably estimable. Assessing probability of loss and estimating probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third party claimants and courts. Recorded contingent liabilities are based on the best information available and actual losses in any future period are inherently uncertain.   Currently, we have accrued approximately $1.9 million related to ongoing litigation matters for which we believe liability is probable and reasonably estimable. Accruals are not made in cases where liability is not probable or the amount cannot be reasonably estimated. Aside from the amounts currently accrued, there is nothing that is reasonably probable. We disclose legal matters when we believe liability is reasonably possible and may be material to our consolidated financial statements.

 

Signature Point Litigation. On June 18, 2010, three real estate development companies filed suit in Kentucky state court against the Bank and Managed Assets of Kentucky (“MAKY”). Signature Point Condominiums LLC, et al. v. PBI Bank, et al., Jefferson Circuit Court, Case No 10-CI-04295. On July 16, 2013, a jury in Louisville, Kentucky returned a verdict against the Bank, awarding the plaintiffs compensatory damages of $1,515,000 and punitive damages of $5,500,000. The case arose from a settlement in which the Bank agreed to release the plaintiffs and guarantors from obligations of more than $26 million related to a real estate project in Louisville. The plaintiffs were granted a right of first refusal to repurchase a tract of land within the project. In exchange, the plaintiffs conveyed the real estate securing the loans to the Bank. After plaintiffs declined to exercise their right of first refusal, the Bank sold the tract to the third party. Plaintiffs alleged the Bank had knowledge of the third party offer before the conveyance of the land by the Plaintiffs to the Bank. Plaintiffs asserted claims of fraud, breach of fiduciary duty, breach of the duty of good faith and fair dealing, tortious interference with prospective business advantage and conspiracy to commit fraud, negligence, and conspiracy against the Bank.

 

After conferring with its legal advisors, the Bank believes the findings and damages are excessive and contrary to law, and that it has meritorious grounds on which it has moved to appeal. The Bank’s Notice of Appeal was filed on October 25, 2013. After a number of procedural issues were resolved, the Bank filed its appellate brief on September 30, 2014. Appellee’s brief was filed on December 1, 2014. The Appellate Court will hear oral arguments on November 17, 2015. We will continue to defend this matter vigorously. Although we have made provisions in our consolidated financial statements for this self-insured matter, the amount of our legal accrual is less than the original amount of the damages awarded, plus accrued interest. The ultimate outcome of this matter could have a material adverse effect on our financial condition, results of operations or cash flows.

 

SBAV LP Litigation. On December 17, 2012, SBAV LP filed a lawsuit against the Company, the Bank, J. Chester Porter and Maria L. Bouvette in New York state court.  The proceeding was removed to New York federal district court on January 16, 2013, and on February 27, 2013, SBAV LP filed an Amended Complaint. On July 10, 2013, the New York federal district court granted the defendants’ motion to transfer the case to federal district court in Kentucky.  SBAV LP v. Porter Bancorp, et. al., Civ. Action 3:13-CV-710 (W.D.KY).  The Amended Complaint alleged a violation of the Kentucky Securities Act and negligent misrepresentation against all named defendants, and breach of contract against Porter Bancorp alone. The plaintiff sought damages in an amount in excess of $4,500,000, or the difference between the $5,000,016 purchase price and the value of the securities when tendered by the plaintiff, plus interest at the applicable statutory rate, costs and reasonable attorneys’ fees.   We and other defendants disputed the material factual allegations made in the Amended Complaint, and on September 13, 2013, filed a motion to dismiss all claims in the complaint for pleading failures and for failure to state a claim upon which relief may be granted. On March 25, 2014, the judge ruled that SBAV had failed to state a claim against the Bank and dismissed the Bank from the case. On November 2, 2015, the parties agreed to settle the litigation and executed a confidential written settlement agreement. The settlement of this litigation did not have a material adverse effect on the Company’s financial condition or results of operations.

 

  

Millers Health System Inc. Employee Stock Ownership Plan. On December 26, 2013, the United States Department of Labor (“DOL”) filed a lawsuit against the Bank in U.S. District Court for the Northern District of Indiana. Thomas E. Perez, Secretary of the United States Department of Labor v. PBI Bank, Inc. (Civ. Action 3:13-CV-1400-PPS). The complaint alleges that in 2007 the Bank, in the capacity of trustee for the Miller’s Health System’s Inc. Employee Stock Ownership Plan, authorized the alleged imprudent and disloyal purchase of the stock of Miller’s Health Systems, Inc. (“Miller’s Health”) in 2007 for $40 million, a price allegedly far in excess of the stock’s fair market value. The suit also alleges, among other things, that the Bank approved 100% seller financing for the transaction at an excessive rate of interest. On March 31, 2014, the Bank filed its answer, disputing the material factual allegations of the complaint. On April 10, 2014, the Bank filed a third-party complaint against Miller’s Health seeking to enforce its indemnity rights, as well as third party claims for contribution against named directors and officers of Miller’s Health. On March 12, 2015, the parties agreed to settle the litigation and executed a written settlement agreement on July 10, 2015. The Bank agreed to a settlement payment, which, to the extent not paid from insurance proceeds, had been previously reserved for. The court entered an agreed order ending the litigation on July 20, 2015.

 

AIT Laboratories Employee Stock Ownership Plan. On August 29, 2014, the United States Department of Labor (“DOL”) filed a lawsuit against the Bank and Michael A. Evans in the U.S. District Court for the Southern District of Indiana. Thomas E. Perez, Secretary of the United States Department of Labor v. PBI Bank, Inc. and Michael A. Evans (Case No. 1:14-CV-01429-SEB-MJD). The complaint alleges that in 2009, the Bank, in the capacity of trustee for the AIT Laboratories Employee Stock Ownership Plan, authorized the alleged imprudent and disloyal purchase of the stock of AIT Holdings, Inc. in 2009 for $90 million, a price allegedly far in excess of the stock’s fair market value. The Bank's responsive pleading was filed on November 4, 2014, disputing the material factual allegations that have been made by the DOL. A settlement conference has been set for November 19, 2015, and a trial date has been set for November 7, 2016. We intend to defend against DOL’s claims vigorously. 

 

United States Department of Justice Investigation. On October 17, 2014, the United States Department of Justice (the “DOJ”) notified the Bank that the Bank was the subject of an investigation into possible violations of federal laws, including, among other things, possible violations related to false bank entries, bank fraud and securities fraud.  The investigation concerns allegations that Bank personnel engaged in practices intended to delay or avoid disclosure of the Bank’s asset quality at the time of and following the United States Treasury’s purchase of preferred stock from the Company in November 2008.  The Bank will respond to and cooperate with any requests for information from DOJ. At this time the investigation is ongoing, and DOJ has made no determination whether to pursue any action in the matter. 

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This item analyzes our financial condition, change in financial condition and results of operations. It should be read in conjunction with the unaudited consolidated financial statements and accompanying notes presented in Part I, Item 1 of this report.

 

Cautionary Note Regarding Forward-Looking Statements

 

This report contains statements about the future expectations, activities and events that constitute forward-looking statements. Forward-looking statements express our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.

 

Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future results we expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be out of our control. Factors that could contribute to differences in our results include, but are not limited to the following:

 

 

Our inability to increase our capital to the levels required by our agreements with bank regulators could have a material adverse effect on our business.

 

 

A significant percentage of our loan portfolio is comprised of non-owner occupied commercial real estate loans, real estate construction and development loans, and multi-family residential real estate loans, all of which carry a higher degree of risk.

 

 

We continue to hold and acquire a significant amount of OREO properties, which could increase operating expenses and result in future losses.

 

 

Our decisions regarding credit risk may not be accurate, and our allowance for loan losses may not be sufficient to cover actual losses.

 

 

Our ability to pay cash dividends on our common and preferred stock and pay interest on the junior subordinated debentures that relate to our trust preferred securities is currently restricted. Our inability to resume paying interest on our trust preferred securities could adversely affect our common and preferred shareholders.

 

 

While we believe our provision for legal contingencies is adequate, the outcome of legal proceedings is difficult to predict and we may settle legal claims or be subject to judgments for amounts that exceed our estimates.

 

We also refer you to Part II, Item 1A – Risk Factors in this report and to the risks identified and the cautionary statements discussed in greater detail in our December 31, 2014 Annual Report on Form 10-K.

 

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and they are reasonable. We caution you however, forward looking statements relying upon such assumptions or bases almost always vary from actual results, and the differences between those statements and actual results can be material. The forward-looking statements included in this report speak only as of the date of the report.  We have no duty, and do not intend to, update these statements unless applicable laws require us to do so.

 

Overview 

 

Porter Bancorp, Inc. (the “Company”) is a bank holding company headquartered in Louisville, Kentucky. Our wholly owned subsidiary PBI Bank (“the Bank”) is the sixth largest bank domiciled in the Commonwealth of Kentucky based on total assets. We operate banking offices in twelve counties in Kentucky. Our markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt. We serve south central Kentucky and southern Kentucky from banking offices in Butler, Green, Hart, Edmonson, Barren, Warren, Ohio, and Daviess Counties. We also have an office in Lexington, the second largest city in Kentucky. The Bank is a community bank with a wide range of commercial and personal banking products. As of September 30, 2015, we had total assets of $951.5 million, total loans of $624.4 million, total deposits of $877.9 million and stockholders’ equity of $33.8 million.

 

The Company reported a net loss of $1.1 million and $2.6 million for the three and nine months ended September 30, 2015, respectively, compared with a net loss of $849,000 and $7.4 million for the same periods of 2014, respectively.  After deductions for losses allocated to participating securities, net loss attributable to common shareholders was $1.0 million and $2.3 million for the three and nine months ended September 30, 2015, respectively, compared with net loss attributable to common shareholders of $1.5 million and $8.8 million for the three and nine months ended September 30, 2014, respectively.

 

  

Basic and diluted loss per common share were ($0.04) and ($0.10) for the three and nine months ended September 30, 2015, respectively, compared with basic and diluted loss per common share of ($0.12) and ($0.73) for the three and nine months ended September 30, 2014, respectively.

 

The following significant items are of note for the three and nine months ended September 30, 2015:

 

 

On September 30, 2015, we completed a common equity for debt exchange with holders of $4.0 million of the capital securities (the “Trust Securities”) of Porter Statutory Trust IV, a trust subsidiary of the Company. Accrued and unpaid interest on the Trust Securities totaled of approximately $330,000. In exchange for the $4.3 million debt and interest liability, the Company issued 800,000 common shares and 400,000 non-voting common shares, for a total of 1,200,000 shares. In the transaction, a wholly owned subsidiary of the Company received a one-third portion of the Trust Securities directly from an unrelated third party in exchange for 400,000 common shares resulting in an $883,000 gain on extinguishment of debt. The subsidiary also received two-thirds of the Trust Securities from related parties in exchange for 400,000 common shares and 400,000 non-voting common shares. The debt and interest liability exchanged with related parties was treated as a capital transaction.

 

 

Negative provision expense of $2.2 million was recorded in the first nine months of 2015, compared to a provision for loan losses expense of $6.3 million for the first nine months of 2014, because of declining historical loss rates, improvements in asset quality, and management’s assessment of risk in the loan portfolio. Net charge-offs were $3.0 million for the first nine months of 2015, compared to $10.2 million for the nine months ended September 30, 2014. Net charge-offs were $411,000 for the third quarter of 2015, compared to $1.8 million for the quarter ended June 30, 2015. See additional discussion below regarding improving trends in non-performing loans, past due loans, and risk categories during the period, factors which led to the negative provision expense.

 

 

Non-performing loans decreased $30.3 million to $17.0 million at September 30, 2015, compared with $47.3 million at December 31, 2014. The decrease in non-performing loans was primarily due to $25.1 million in paydowns, $4.4 million in transfers to OREO, and $4.4 million in charge-offs. Non-performing loans decreased $13.3 million to $17.0 million at September 30, 2015, compared with $30.3 million at June 30, 2015. The decrease in non-performing loans was primarily due to $9.0 million in paydowns, $3.5 million in transfers to OREO, and $1.3 million in charge-offs.

 

 

Loans past due 30-59 days decreased from $4.0 million at December 31, 2014 to $2.0 million at September 30, 2015 and loans past due 60-89 days decreased from $980,000 at December 31, 2014 to $578,000 at September 30, 2015. Total loans past due and nonaccrual loans decreased to $19.5 million at September 30, 2015 from $52.3 million at December 31, 2014. Loans past due 30-59 days increased slightly from $1.9 million at June 30, 2015 to $2.0 million at September 30, 2015 and loans past due 60-89 days decreased from $650,000 at June 30, 2015 to $578,000 at September 30, 2015. Total loans past due and nonaccrual loans decreased to $19.5 million at September 30, 2015 from $32.9 million at June 30, 2015.

 

 

All loan risk categories (other than pass loans) have decreased since December 31, 2014. Pass loans represent 81.4% of the portfolio at September 30, 2015, compared to 78.6% at June 30, 2015, and 73.8% at December 31, 2014. The pass category increased approximately $47.3 million, the watch category decreased approximately $1.5 million, the special mention category declined approximately $2.5 million, and the substandard category declined approximately $44.0 million. The $44.0 million decrease in loans classified as substandard was primarily driven by $33.2 million in principal payments received, $4.5 million in migration to OREO, $10.4 million in loans upgraded from substandard, and $5.0 million in charge-offs, offset by $9.0 million in loans moved to substandard during the nine months ended September 30, 2015. Since June 30, 2015, the pass category decreased approximately $1.4 million, the watch category decreased $986,000, the special mention category declined approximately $18,000, and the substandard category declined approximately $21.5 million, reflecting the overall decrease in the loan portfolio during the quarter.

 

 

Foreclosed properties were $29.2 million at September 30, 2015, compared with $46.2 million at December 31, 2014, and $54.5 million at September 30, 2014.  During the first nine months of 2015, the Company acquired $4.5 million and sold $14.4 million of OREO. We incurred OREO losses totaling $7.1 million during the first nine months of 2015, reflecting fair value write-downs for reductions in listing prices for certain properties, updated appraisals, and certain properties liquidated through auctions near and after the end of the third quarter, offset by $27,000 in net gain on sales of OREO. Late in the third quarter of 2015, the Bank determined to liquidate 18 parcels of OREO with an aggregate book value at that time of $4.0 million through absolute auctions. The auctions resulted in final bids less estimated selling costs of $1.8 million. Fair value write-downs of $2.2 million were recorded in the third quarter of 2015 related to these properties, and cash settlement is expected to occur in the fourth quarter of 2015. OREO expense may be elevated in future periods as we work to sell these properties, given the current size of the OREO portfolio. At quarter end, $6.5 million of OREO property was subject to a contract for sale or letter of intent, including the $1.8 million in expected net proceeds resulting from the auctions discussed above.

  

 

 

Our ratio of non-performing assets to total assets decreased to 4.85% at September 30, 2015, compared with 7.13% at June 30, 2015, 9.19% at December 31, 2014, and 9.62% at September 30, 2014.

 

 

Net interest margin increased 19 basis points to 3.25% in the first nine months of 2015 compared with 3.06% in the first nine months of 2014. The increase in margin between periods was primarily due to a decrease in the cost of interest bearing liabilities from 1.14% in the first nine months of 2014 to 0.87% in the first nine months of 2015. The decrease in cost of interest bearing liabilities was primarily driven by the continued repricing of certificates of deposit at lower rates. Average loans decreased 4.5% to $641.5 million in the first nine months of 2015 compared with $671.7 million in the first nine months of 2014.  Net loans decreased 0.6% to $610.2 million at September 30, 2015, compared with $614.2 million at September 30, 2014.

 

 

Non-interest income increased $3.6 million to $6.5 million compared with $2.9 million for the first nine months of 2014 driven primarily by gains on the sales of securities totaling $1.7 million in the first nine months of 2015, compared to $92,000 in the first nine months of 2014, as well as an increase in OREO rental income of $1.1 million between the two periods. The increase in OREO income is the result of several larger properties with tenants being transferred to OREO in the second quarter of 2014. Non-interest income also increased due an $883,000 gain on extinguishment of debt.

 

 

Non-interest expense increased $5.8 million to $33.4 million compared with $27.6 million for the first nine months of 2014, due to an increase in OREO expenses of $6.8 million primarily related to fair value write-downs for the first nine months of 2015, and an increase in professional fees of $1.2 million related to legal fees and litigation expenses, offset by a decrease in loan collection expenses of $1.8 million.

 

 

Deposits decreased 5.3% to $877.9 million at September 30, 2015 compared with $926.8 million at December 31, 2014. Certificate of deposit balances decreased $40.7 million during the first nine months of 2015 to $534.0 million at September 30, 2015, from $574.7 million at December 31, 2014. Demand deposits decreased 7.6% during the first nine months of 2015 compared with December 31, 2014.

 

 

On February 25, 2015, we completed the final step in the retirement of our preferred stock originally issued to the U.S. Treasury when shareholders approved the conversion of all mandatorily convertible Series B Preferred Shares into 4,053,600 common shares and the conversion of all mandatorily convertible Series D Preferred Shares into 6,458,000 non-voting common shares. The conversion reduced preferred stockholders’ equity by $5.8 million and increased common stockholders’ equity by the same amount. Total issued and outstanding common shares and non-voting common shares were 26,949,205 at September 30, 2015.

 

 

On June 24, 2015, the Board of Directors approved the adoption of a tax benefits preservation plan designed to preserve the value of certain of the Company's deferred tax assets primarily associated with net operating loss carryforwards (NOLs) under Section 382 of the Internal Revenue Code. The plan is intended to reduce the likelihood of an “ownership change” occurring as a result of the buying and selling of the Company's common stock. The tax benefits preservation plan is more fully described in Note 9 – “Income Taxes”. On September 23, 2015, the Company’s shareholders approved an amendment to its articles of incorporation to help protect the long-term value to the Company of its NOLs. The amendment is designed to block transfers of our common shares that could result in an ownership change (the “NOL Protective Amendment”). At September 30, 2015, the Company’s net deferred tax asset totaled $52.2 million and was subject to a full valuation allowance.

 

Going Concern Considerations and Future Plans

 

The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business for the foreseeable future. However, the events and circumstances described in this Note create substantial doubt about the Company’s ability to continue as a going concern.

 

In June 2011, the Bank agreed to a Consent Order with the FDIC and KDFI in which the Bank agreed, among other things, to improve asset quality, reduce loan concentrations, and maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. In October 2012, the Bank entered into a revised Consent Order with the FDIC and KDFI again agreeing to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Bank also agreed that if it should be unable to reach the required capital levels, and if directed in writing by the FDIC, then the Bank would within 30 days develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution or otherwise immediately obtain a sufficient capital investment into the Bank to fully meet the capital requirements. In October 2015, the Bank agreed to enter into a revised Consent Order, which includes several of the substantive provisions of the June 2011 and October 2012 Consent Orders, but omits previous provisions related to reducing loan concentrations that the Bank has satisfied. The revised Consent Order requires the Bank to continue to adhere to the plans implemented in response to the previous Consent Orders. The revised Consent Order is included as an exhibit to this report.

 

  

We continue to work toward capital ratio compliance. As of September 30, 2015, the Bank’s Tier 1 leverage ratio and total risk based capital ratio were both less than the minimum capital ratios required by the Consent Order. Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a consent order. Based on individual circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious adverse actions such as directing a bank to seek a buyer or taking a bank into receivership.

 

At September 30, 2015, we continued to be involved in various legal proceedings in which we dispute the material factual allegations against us. After conferring with our legal advisors, we believe we have meritorious grounds on which to prevail. If we do not prevail, the ultimate outcome of any one of these matters could have a material adverse effect on our financial condition, results of operations, or cash flows. These matters are more fully described in Note 13 – “Contingencies”.

 

The Board of Directors and management continue to evaluate and implement strategies to meet the obligations of the Consent Order. These include: 

 

 

Increasing capital through the limited issuance of common stock to new and existing shareholders.

 

 

Continuing to operate the Company and Bank in a safe and sound manner. We have reduced our lending concentrations and the size of our balance sheet, while continuing to remediate non-performing loans.

 

 

In executing on our commitment to improve credit quality, reduce loan concentrations, and reduce balance sheet risk, we have:

 

 

o  

Reduced the size of our loan portfolio significantly from $1.3 billion at December 31, 2010 to $624.4 million at September 30, 2015.   

 

 

o

Reduced our construction and development loans to less than 75% of total risk-based capital at September 30, 2015.

 

 

o

Reduced our non-owner occupied commercial real estate loans, construction and development loans, and multi-family residential real estate loans.  These loans represented 221% of total risk-based capital at September 30, 2015, down from 262% at December 31, 2014.

 

 

Executing on our commitment to sell OREO and reinvest in quality income producing assets.

 

 

o

Our acquisition of real estate assets through the loan remediation process increased during 2014, as we acquired $32.3 million of OREO in 2014 compared with $20.6 million during 2013. We acquired $4.5 million in the first nine months of 2015. However, nonaccrual loans totaled $17.0 million at September 30, 2015, and we expect to resolve a portion of these loans by foreclosure, which may result in further additions to our OREO portfolio.

     
  o We incurred OREO losses totaling $7.1 million during the first nine months of 2015, the result of fair value write-downs to reflect reductions in listing prices for certain properties, updated appraisals, and the liquidation of other properties through auctions near and after the end of the third quarter, offset by a $27,000 net gain on sales of OREO. Proceeds from the sale of OREO totaled $14.4 million for the nine months ended September 30, 2015, and $7.3 million for the nine months ended September 30, 2014. OREO expense may be elevated in future periods as we work to sell these properties, given the current size of the OREO portfolio. At quarter end, $6.5 million of OREO property was subject to a contract for sale or letter of intent.

 

 

o

Real estate construction represents 50% of the OREO portfolio at September 30, 2015 compared with 40% at December 31, 2014. Commercial real estate represents 41% of the OREO portfolio at September 30, 2015 compared with 31% at December 31, 2014, and 1-4 family residential properties represent 9% of the portfolio at September 30, 2015 compared with 17% at December 31, 2014.

 

 

 Continuing to improve our internal processes and procedures, distribution of labor, and work-flow to ensure we have adequately and appropriately deployed resources in an efficient manner in the current environment.

 

The Company’s liquid assets were $1.2 million at September 30, 2015. Since the Bank is unlikely to be in a position to pay dividends to the parent company for the foreseeable future, cash inflows for the parent are limited to earnings on investment securities, sales of investment securities, interest on deposits with the Bank, the issuance of new debt, or the issuance of capital securities. Ongoing operating expenses of the parent company are forecasted at approximately $1.0 million for the next twelve months.

 

Effective with the fourth quarter of 2011, we began deferring interest payments on the junior subordinated debentures relating to our trust preferred securities. Deferring interest payments on the junior subordinated debentures resulted in a deferral of distributions on our trust preferred securities. If we defer distributions on our trust preferred securities for 20 consecutive quarters, we must pay all deferred distributions in full or we will be in default. Our deferral period expires in the third quarter of 2016. Deferred distributions on our trust preferred securities, which totaled $2.3 million as of September 30, 2015, are cumulative, and unpaid distributions accrue and compound on each subsequent payment date. If as a result of a default we become subject to any liquidation, dissolution or winding up, holders of the trust preferred securities will be entitled to receive the liquidation amounts to which they are entitled, including all accrued and unpaid distributions, before any distribution can be made to our shareholders. In addition, the holders of our Series E and Series F Preferred Shares will be entitled to receive liquidation distributions totaling $10.5 million before any distribution can be made to the holders of our common shares.

 

  

On September 30, 2015, we completed a common equity for debt exchange with holders of $4.0 million of the capital securities (the “Trust Securities”) of Porter Statutory Trust IV, a trust subsidiary of the Company. Accrued and unpaid interest on the Trust Securities totaled approximately $330,000. In exchange for the $4.3 million debt and interest liability, the Company issued 800,000 common shares and 400,000 non-voting common shares, for a total of 1,200,000 shares. In the transaction, a wholly owned subsidiary of the Company received a one-third portion of the Trust Securities directly from an unrelated third party in exchange for 400,000 common shares, resulting in an $883,000 gain on extinguishment of debt. The subsidiary also received two-thirds of the Trust Securities from related parties in exchange for 400,000 common shares and 400,000 non-voting common shares. The debt and interest liability exchanged with related parties was treated as a capital transaction.

 

Application of Critical Accounting Policies

 

We continually review our accounting policies and financial information disclosures. Our more significant accounting policies that require the use of estimates and judgments in preparing the financial statements are summarized in “Application of Critical Accounting Policies” in Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation of our Annual Report on Form 10-K for the calendar year ended December 31, 2014. Management has discussed the development, selection, and application of our critical accounting policies with our Audit Committee. During the first nine months of 2015, there were no material changes in the critical accounting policies and assumptions.

 

Results of Operations

 

The following table summarizes components of income and expense and the change in those components for the three months ended September 30, 2015, compared with the same period of 2014:

 

   

For the Three Months

   

Change from

 
   

Ended September 30,

   

Prior Period

 
   

2015

   

2014

   

Amount

   

Percent

 
   

(dollars in thousands)

 
                                 

Gross interest income

  $ 9,179     $ 9,814     $ (635

)

    (6.5

)%

Gross interest expense

    1,697       2,477       (780

)

    (31.5

)

Net interest income

    7,482       7,337       145       2.0  

Provision (negative provision) for loan losses

    (2,200

)

          (2,200

)

    (100.0

)

Non-interest income

    2,210       1,057       1,153       109.1  

Non-interest expense

    12,968       9,281       3,687       39.7  

Net loss before taxes

    (1,076

)

    (887

)

    (189

)

    21.3  

Income tax benefit

          (38

)

    38       (100.0

)

Net loss

    (1,076

)

    (849

)

    (227

)

    26.7  

 

Net loss before taxes for the three months ended September 30, 2015 totaled $1.1 million, compared with a net loss before taxes of $887,000 for the comparable period of 2014.

 

Net interest income increased $145,000 from the third quarter of 2014 and was adversely affected by the reduction in net interest earning assets as well as interest lost on nonaccrual loans in the third quarters of 2015 and 2014 of $352,000 and $616,000, respectively. A negative provision for loan losses of $2.2 million was recorded in the first nine months of 2015 because of significant improvements in asset quality and management’s assessment of risk in the loan portfolio.

 

Non-interest income increased to $2.2 million from $1.1 million in the third quarter of 2014. The $1.2 million increase was primarily due to an increase in OREO rental income of $375,000, and an $883,000 gain on extinguishment of junior subordinated debt. Non-interest expense also increased during the period from $9.3 million to $13.0 million for the three months ended September 30, 2014 and 2015, respectively. This increase was primarily due to increases in OREO expenses of $4.6 million, offset by a reduction in loan collection expenses of $537,000. OREO expense may be elevated in future periods as we work to sell these properties, given the current size of the OREO portfolio. Additionally, nonaccrual loans totaled $17.0 million at September 30, 2015, and we expect to resolve many of these loans by foreclosure which could result in further additions to our OREO portfolio.    

 

  

A tax benefit was recognized in the third quarter of 2014 due to gains in other comprehensive income that are presented in current operations. The calculation for the income tax provision or benefit generally does not consider the tax effects of changes in other comprehensive income, or OCI, which is a component of stockholders’ equity on the balance sheet. However, an exception is provided in certain circumstances, such as when there is a full valuation allowance against net deferred tax assets, there is a loss from continuing operations and there is income in other components of the financial statements. In such a case, pre-tax income from other categories, such as changes in OCI, must be considered in determining a tax benefit to be allocated to the loss from continuing operations. For the quarter ended September 30, 2014, this resulted in $38,000 of income tax benefit allocated to continuing operations. The September 30, 2014 tax benefit is entirely due to gains in other comprehensive income that are presented in current operations in accordance with applicable accounting standards. There was no tax benefit recorded during the quarter ended September 30, 2015. Net loss after recognition of the tax benefit was $849,000 for the third quarter of 2014.

 

The following table summarizes components of income and expense and the change in those components for the nine months ended September 30, 2015, compared with the same period of 2014:

 

   

For the Nine Months

   

Change from

 
   

Ended September 30,

   

Prior Period

 
   

2015

   

2014

   

Amount

   

Percent

 
   

(dollars in thousands)

 
                                 

Gross interest income

  $ 27,549     $ 29,877     $ (2,328

)

    (7.8

)%

Gross interest expense

    5,438       7,626       (2,188

)

    (28.7

)

Net interest income

    22,111       22,251       (140

)

    (0.6

)

Provision (negative provision) for loan losses

    (2,200

)

    6,300       (8,500

)

    (134.9

)

Non-interest income

    6,471       2,921       3,550       121.5  

Non-interest expense

    33,394       27,587       5,807       21.0  

Net loss before taxes

    (2,612

)

    (8,715

)

    6,103       (70.0

)

Income tax benefit

          (1,345

)

    1,345       (100.0

)

Net loss

    (2,612

)

    (7,370

)

    4,758       (64.6

)

 

Net loss before taxes for the nine months ended September 30, 2015 totaled $2.6 million, compared with a net loss before taxes of $8.7 million for the comparable period of 2014.  After the tax benefit recorded in the third quarter as noted above, net loss for the first nine months of 2014 was $7.4 million. Provision for loan losses expense decreased $8.5 million for the first nine months of 2015 compared with the same period in 2014, due to the $2.2 million negative provision recorded in 2015 as compared to provision for loan losses expense of $6.3 million in the first nine months of 2014. Net charge-offs were $3.0 million for the nine months ended June 30, 2015, compared to $10.2 million for the same period in 2014.

 

Net interest income decreased $140,000 from the first nine months of 2014 and was adversely affected by a reduction in net interest earning assets as well as interest lost on nonaccrual loans which totaled $1.4 million in the first nine months of 2015 and $2.7 million for the comparable period of 2014. Non-interest income increased by $3.6 million to $6.5 million from $2.9 million for the first nine months of 2014, primarily due to increases in net gains on sales of securities and OREO rental income, as well an $883,000 gain on extinguishment of junior subordinated debt in the third quarter.

 

Non-interest expense also increased during the period from $27.6 million to $33.4 million for the nine months ended September 30, 2014 and 2015, respectively. This increase was primarily due to increases in OREO expenses of $6.8 million and professional fees of $1.2 million, offset by decreases in loan collection expenses of $1.8 million and state franchise and deposit taxes of $380,000. OREO expense was elevated during the first nine months of 2015 due to write-downs of $7.1 million resulting from declines in fair value of the real estate based upon reductions in listing prices, updated appraisals, and certain properties liquidated through auctions near and after the end of the third quarter. Professional fees are elevated for 2015 as a result of current litigation as described in Note 13 – “Contingencies”.

 

Net Interest Income – Our net interest income was $7.5 million for the three months ended September 30, 2015, an increase of $145,000, or 2.0%, compared with $7.3 million for the same period in 2014.  Net interest spread and margin were 3.24% and 3.33%, respectively, for the third quarter of 2015, compared with 3.00% and 3.10%, respectively, for the third quarter of 2014. Net average nonaccrual loans were $26.0 million and $43.3 million for the third quarters of 2015 and 2014, respectively. Cost of funds decreased 30 basis points from 1.13% in the third quarter of 2014 to 0.83% for the third quarter of 2015.

 

Average loans receivable declined approximately $57,000 for the quarter ended September 30, 2015 compared with the third quarter of 2014, and the average yield decreased from 5.08% for the third quarter of 2014 to 4.89% for the third quarter of 2015.  This resulted in a decline in interest revenue of approximately $306,000 for the quarter ended September 30, 2015 compared with the prior year period.

 

Net interest margin increased 23 basis points from our margin of 3.10% in the prior year third quarter.  The yield on earning assets decreased six basis points from the third quarter of 2014, compared with a 30 basis point decline in rates paid on interest-bearing liabilities. The increase in net interest margin was offset by a decrease in earning assets which resulted in a $145,000 increase in net interest income.  

 

 

Net interest income was $22.1 million for the nine months ended September 30, 2015, a decrease of $140,000, or 0.6%, compared with $22.3 million for the same period in 2014.  Net interest spread and margin were 3.16% and 3.25%, respectively, for the first nine months of 2015, compared with 2.95% and 3.06%, respectively, for the first nine months of 2014. Net average nonaccrual loans were $34.5 million and $68.2 million for the first nine months of 2015 and 2014, respectively. Cost of funds decreased 27 basis points from 1.14% for the first nine months of 2014 to 0.87% for the first nine months of 2015.

 

Average loans receivable declined approximately $30.2 million for the nine months ended September 30, 2015 compared with the first nine months of 2014.  This resulted in a decline in interest revenue of approximately $1.6 million for the nine months ended September 30, 2015 compared with the prior year period.

 

Net interest margin increased 19 basis points from our margin of 3.06% in the first nine months of 2014.  The yield on earning assets decreased six basis points from the first nine months of 2014, compared with a 27 basis point decline in rates paid on interest-bearing liabilities. The increase in net interest margin was offset by a decrease in earning assets which resulted in a $140,000 reduction in net interest income.

 

 

Average Balance Sheets

 

The following table presents the average balance sheets for the three month periods ended September 30, 2015 and 2014, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

 

   

Three Months Ended September 30,

 
   

2015

   

2014

 
   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

 
   

(dollars in thousands)

 

ASSETS

                                               

Interest-earning assets:

                                               

Loan receivables (1)(2)

  $ 639,954     $ 7,895       4.89

%

  $ 640,011     $ 8,201       5.08

%

Securities

                                               

Taxable

    165,692       986       2.36       199,912       1,265       2.51  

Tax-exempt (3)

    24,819       187       4.60       30,071       231       4.69  

FHLB stock

    7,323       73       3.95       7,323       73       3.95  

Other equity securities

                      1              

Federal funds sold and other

    66,069       38       0.23       76,899       44       0.23  

Total interest-earning assets

    903,857       9,179       4.07

%

    954,217       9,814       4.13

%

Less: Allowance for loan losses

    (16,818

)

                    (25,045

)

               

Non-interest earning assets

    81,432                       104,646                  

Total assets

  $ 968,471                     $ 1,033,818                  
                                                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

                                               

Interest-bearing liabilities:

                                               

Certificates of deposit and other time deposits

  $ 546,502     $ 1,267       0.92

%

  $ 625,808     $ 2,064       1.31

%

NOW and money market deposits

    198,752       192       0.38       173,344       160       0.37  

Savings accounts

    35,348       17       0.19       36,812       21       0.23  

Repurchase agreements

    382                   2,354       1       0.17  

FHLB advances

    3,315       23       2.75       4,803       31       2.56  

Junior subordinated debentures

    29,454       198       2.67       30,399       200       2.61  

Total interest-bearing liabilities

    813,753       1,697       0.83

%

    873,520       2,477       1.13

%

                                                 

Non-interest-bearing liabilities:

                                               

Non-interest-bearing deposits

    112,660                       112,025                  

Other liabilities

    11,138                       17,172                  

Total liabilities

    937,551                       1,002,717                  

Stockholders’ equity

    30,920                       31,101                  

Total liabilities and stockholders’ equity

  $ 968,471                     $ 1,033,818                  
                                                 

Net interest income

          $ 7,482                     $ 7,337          
                                                 

Net interest spread

                    3.24

%

                    3.00

%

                                                 

Net interest margin

                    3.33

%

                    3.10

%

 

(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans averaging $26.0 million and $43.3 million, respectively, in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

 

 

The following table presents the average balance sheets for the nine month periods ended September 30, 2015 and 2014, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods. 

 

   

Nine Months Ended September 30,

 
   

2015

   

2014

 
   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

 
   

(dollars in thousands)

 

ASSETS

                                               

Interest-earning assets:

                                               

Loan receivables (1)(2)

  $ 641,489     $ 23,496       4.90

%

  $ 671,733     $ 25,094       4.99

%

Securities

                                               

Taxable

    171,960       3,122       2.43       186,481       3,653       2.62  

Tax-exempt (3)

    25,580       580       4.66       30,565       707       4.76  

FHLB stock

    7,323       219       4.00       7,907       264       4.46  

Other equity securities

                      29              

Federal funds sold and other

    76,966       132       0.23       91,316       159       0.23  

Total interest-earning assets

    923,318       27,549       4.03

%

    988,031       29,877       4.09

%

Less: Allowance for loan losses

    (18,030

)

                    (26,058

)

               

Non-interest earning assets

    89,067                       92,619                  

Total assets

  $ 994,355                     $ 1,054,592                  
                                                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

                                               

Interest-bearing liabilities:

                                               

Certificates of deposit and other time

deposits

  $ 572,243     $ 4,173       0.97

%

  $ 646,157     $ 6,388       1.32

%

NOW and money market deposits

    195,887       544       0.37       172,012       470       0.37  

Savings accounts

    36,003       58       0.22       36,997       67       0.24  

Repurchase agreements

    785       1       0.17       2,303       3       0.17  

FHLB advances

    3,583       74       2.76       4,648       96       2.76  

Junior subordinated debentures

    29,706       588       2.65       30,621       602       2.63  

Total interest-bearing liabilities

    838,207       5,438       0.87

%

    892,738       7,626       1.14

%

                                                 

Non-interest-bearing liabilities:

                                               

Non-interest-bearing deposits

    112,326                       110,809                  

Other liabilities

    10,946                       15,832                  

Total liabilities

    961,479                       1,019,379                  

Stockholders’ equity

    32,876                       35,213                  

Total liabilities and stockholders’ equity

  $ 994,355                     $ 1,054,592                  
                                                 

Net interest income

          $ 22,111                     $ 22,251          
                                                 

Net interest spread

                    3.16

%

                    2.95

%

                                                 

Net interest margin

                    3.25

%

                    3.06

%

  

(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans averaging $34.5 million and $68.2 million, respectively, in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

  

 

Rate/Volume Analysis

 

 The table below sets forth certain information regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes in volume (changes in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.

 

   

Three Months Ended September 30,

2015 vs. 2014

   

Nine Months Ended September 30

2015 vs. 2014

 
   

Increase (decrease)

due to change in

   

Increase (decrease)

due to change in

 
   

Rate

   

Volume

   

Net

Change

   

Rate

   

Volume

   

Net

Change

 
   

(in thousands)

 

Interest-earning assets:

                                               

Loan receivables

  $ (305

)

  $ (1

)

  $ (306

)

  $ (483

)

  $ (1,115

)

  $ (1,598

)

Securities

    (77

)

    (246

)

    (323

)

    (281

)

    (377

)

    (658

)

FHLB stock

                      (27

)

    (18

)

    (45

)

Other equity securities

                                   

Federal funds sold and other

          (6

)

    (6

)

    (2

)

    (25

)

    (27

)

Total increase (decrease) in interest income

    (382

)

    (253

)

    (635

)

    (793

)

    (1,535

)

    (2,328

)

                                                 

Interest-bearing liabilities:

                                               

Certificates of deposit and other time deposits

    (558

)

    (239

)

    (797

)

    (1,542

)

    (673

)

    (2,215

)

NOW and money market accounts

    7       25       32       8       66       74  

Savings accounts

    (3

)

    (1

)

    (4

)

    (7

)

    (2

)

    (9

)

Federal funds purchased and repurchase agreements

    (1

)

          (1

)

          (2

)

    (2

)

FHLB advances

    2       (10

)

    (8

)

          (22

)

    (22

)

Junior subordinated debentures

    4       (6

)

    (2

)

    4       (18

)

    (14

)

Total increase (decrease) in interest expense

    (549

)

    (231

)

    (780

)

    (1,537

)

    (651

)

    (2,188

)

Increase (decrease) in net interest income

  $ 167     $ (22

)

  $ 145     $ 744     $ (884

)

  $ (140

)

 

 

Non-Interest Income – The following table presents the major categories of non-interest income for the three and nine months ended September 30, 2015 and 2014:

 

   

For the Three Months

   

For the Nine Months

 
   

Ended September 30,

   

Ended September 30,

 
   

2015

   

2014

   

2015

   

2014

 
   

(in thousands)

 
                                 

Service charges on deposit accounts

  $ 492     $ 535     $ 1,376     $ 1,490  

Bank card interchange fees

    212       209       644       575  

Other real estate owned rental income

    380       5       1,109       30  

Net gain on sales of securities

          46       1,696       92  

Gain on extinguishment of junior subordinated debt

    883             883        

Other

    243       262       763       734  

Total non-interest income

  $ 2,210     $ 1,057     $ 6,471     $ 2,921  

 

Non-interest income for the third quarter ended September 30, 2015 increased by $1.2 million, or 109.1%, compared with the third quarter of 2014.  For the nine months ended September 30, 2015, non-interest income increased by $3.6 million, or 121.5% to $6.5 million compared with $2.9 million for the same period of 2014.

 

The increase in non-interest income between both the three and nine month comparative periods was due to an $883,000 gain on extinguishment of junior subordinated debt. The increase in non-interest income between the three month comparative periods was also due to a $375,000 increase in OREO rental income. The increase in non-interest income between the nine month comparative periods was primarily due to a $1.6 million increase in net gain on sales of investment securities, as well as an increase in OREO rental income of $1.1 million.

 

 

Non-interest ExpenseThe following table presents the major categories of non-interest expense for the three and nine months ended September 30, 2015 and 2014:

 

   

For the Three Months

   

For the Nine Months

 
   

Ended September 30,

   

Ended September 30,

 
   

2015

   

2014

   

2015

   

2014

 
   

(in thousands)

 
                                 

Salary and employee benefits

  $ 3,920     $ 4,041     $ 11,795     $ 11,731  

Occupancy and equipment

    815       857       2,513       2,645  

Professional fees

    620       361       2,313       1,134  

FDIC insurance

    539       571       1,673       1,682  

Data processing expense

    278       269       860       818  

State franchise and deposit tax

    285       405       855       1,235  

Other real estate owned expense

    5,131       560       8,796       1,996  

Loan collection expense

    321       858       895       2,646  

Other

    1,059       1,359       3,694       3,700  

Total non-interest expense

  $ 12,968     $ 9,281     $ 33,394     $ 27,587  

 

Non-interest expense for the third quarter ended September 30, 2015 increased $3.7 million, or 39.7%, compared with the third quarter of 2014. For the nine months ended September 30, 2015, non-interest expense increased $5.8 million, or 21.0% to $33.4 million compared with $27.6 million for the first nine months of 2014. The increases in non-interest expense for the third quarter and nine months ended September 30, 2015 were primarily attributable to increased OREO expenses due to fair value write-downs and increased professional fees, offset by a decrease in loan collection expenses. OREO expenses increased by $4.6 million and $6.8 million for the three and nine month periods, respectively. Late in third quarter of 2015, the Bank determined to liquidate 18 parcels of OREO with an aggregate book value at that time of $3.9 million through absolute auctions. The auctions resulted in final bids less estimated selling costs of $1.8 million. Fair value write-downs of $2.2 million were recorded in the third quarter of 2015 related to these properties and cash settlement is expected to occur in the fourth quarter of 2015. Loan collection expenses decreased by $537,000 and $1.8 million, respectively for the quarter and nine months ended September 30, 2015 as the second quarter of 2014 was elevated by $860,000 of expense related to a settlement agreement with a borrower, as well as other fees incurred to collect non-performing loans. Professional fees were elevated for both the three and nine month periods of 2015 as a result of current litigation as described in Note 13 – “Contingencies”. State franchise and deposit taxes continue to decrease in connection with lower deposit and capital levels at the Bank.

 

 

Income Tax Expense No income tax expense or benefit was recorded for the first nine months of 2015; an income tax benefit of $1.3 million was recorded for the nine months ended September 30, 2014. Our 2014 tax benefit was entirely due to gains in other comprehensive income that are presented in current operations in accordance with applicable accounting standards. The income tax effect on net loss before taxes for the nine months ended September 30, 2015, increased our deferred tax assets and related valuation allowance by $1.2 million. See discussion in the results of operations above.

 

Effective tax rates differ from the federal statutory rate of 35% applied to income before income taxes due to the following:

 

   

For the Three Months

   

For the Nine Months

 
   

Ended September 30,

   

Ended September 30,

 
   

2015

   

2014

   

2015

   

2014

 
   

(in thousands)

 
                                 

Federal statutory rate times financial statement income

  $ (376

)

  $ (311

)

  $ (914

)

  $ (3,050

)

Effect of:

                               

Valuation allowance

    689       378       1,228       3,257  

Tax-exempt income

    (65

)

    (79

)

    (201

)

    (240

)

Tax benefit from OCI components

          (38

)

          (1,345

)

Non-taxable life insurance income

    (23

)

    (24

)

    (80

)

    (72

)

Other, net

    (225

)

    36       (33

)

    105  

Total

  $     $ (38

)

  $     $ (1,345

)

 

 

Analysis of Financial Condition

 

Total assets decreased $66.5 million, or 6.5%, to $951.5 million at September 30, 2015, from $1.018 billion at December 31, 2014.  This decrease was primarily attributable to a decrease in available for sale securities of $44.0 million, the sale of our loans held for sale of $8.8 million, and a decrease in OREO of $17.0 million, offset by an increase of $4.6 million in net loans receivable. The decrease in available for sale securities was driven by management’s decision during the first nine months of 2015 to reduce interest rate risk and credit risk in the available for sale securities portfolio by selling various securities, which resulted in a net gain on sale of approximately $1.7 million. OREO continued to decline as sales outpaced additions to the portfolio during the period.

 

Loans ReceivableLoans receivable decreased $585,000 during the nine months ended September 30, 2015 to $624.4 million. Net charge-offs of $3.0 million and transfers to OREO of $4.5 million contributed to the net decrease, while loan funding outpaced loan payoffs by approximately $6.9 million.

 

Loan Portfolio CompositionThe following table presents a summary of the loan portfolio at the dates indicated, net of deferred loan fees, by type. There are no foreign loans in our portfolio. Except for commercial real estate and 1-4 family residential real estate, there is no concentration of loans in any industry exceeding 10% of total loans as of September 30, 2015. Loans for retail facilities (included in nonfarm nonresidential commercial real estate below) totaled $71.1 million at December 31, 2014.

 

   

As of September 30,

   

As of December 31,

 
   

2015

   

2014

 
   

Amount

   

Percent

   

Amount

   

Percent

 
           

(dollars in thousands)

         
                                 

Commercial

  $ 84,908       13.59

%

  $ 60,936       9.75

%

Commercial Real Estate

                               

Construction

    31,484       5.04       33,173       5.31  

Farmland

    76,670       12.28       77,419       12.39  

Nonfarm nonresidential

    145,899       23.37       175,452       28.07  

Residential Real Estate

                               

Multi-family

    39,579       6.34       41,891       6.70  

1-4 Family

    204,309       32.72       197,278       31.56  

Consumer

    10,483       1.68       11,347       1.82  

Agriculture

    30,609       4.90       26,966       4.31  

Other

    473       0.08       537       0.09  

Total loans

  $ 624,414       100.0

%

  $ 624,999       100.0

%

 

Loan Portfolio by Risk Category – The following table presents a summary of the loan portfolio at the dates indicated, by risk category.

 

    September 30, 2015     June 30, 2015     March 31, 2015     December 31, 2014  
   

Loans

   

% to

Total

   

Loans

   

% to

Total

   

Loans

   

% to

Total

   

Loans

   

% to

Total

 
   

(dollars in thousands)

 
                                                                 

Pass

  $ 508,470       81.4

%

  $ 509,843       78.6

%

  $ 480,545       76.0

%

  $ 461,126     $ 73.8

%

Watch

    66,726       10.7       67,712       10.4       76,876       12.1       68,200       10.9  

Special Mention

    1,700       0.3       1,718       0.3       1,110       0.2       4,189       0.7  

Substandard

    47,518       7.6       69,048       10.7       73,897       11.7       91,484       14.6  

Doubtful

                                               

Total

  $ 624,414       100.0

%

  $ 648,321       100.0

%

  $ 632,428       100.0

%

  $ 624,999     $ 100.0

%

 

Our loans receivable have decreased $585,000 during the nine months ended September 30, 2015. All loan risk categories (other than pass loans) have decreased since December 31, 2014. The pass category increased approximately $47.3 million, the watch category decreased approximately $1.5 million, the special mention category declined approximately $2.5 million, and the substandard category declined approximately $44.0 million. The $44.0 million decrease in loans classified as substandard was primarily driven by $33.2 million in principal payments received, $4.5 million in migration to OREO, $10.4 million in loans upgraded from substandard, and $5.0 million in charge-offs, offset by $9.0 million in loans moved to substandard during the nine months ended September 30, 2015. 

 

 

Loan Delinquency – The following table presents a summary of loan delinquencies at the dates indicated.

 

   

September 30,

2015

   

June 30,

2015

   

March 31,

2015

   

December 31,

2014

 
   

(in thousands)

 

Past Due Loans:

                               

30-59 Days

  $ 1,972     $ 1,941     $ 4,370     $ 3,960  

60-89 Days

    578       650       1,769       980  

90 Days and Over

          92       18       151  

Total Loans Past Due 30-90+ Days

    2,550       2,683       6,157       5,091  
                                 

Nonaccrual Loans

    16,987       30,215       36,500       47,175  

Total Past Due and Nonaccrual Loans

  $ 19,537     $ 32,898     $ 42,657     $ 52,266  

 

During the nine months ended September 30, 2015, nonaccrual loans decreased by $30.2 million to $17.0 million. This decrease was due to paydowns of $25.1 million, charge-offs of $4.4 million, $4.4 million transferred to OREO, and $1.6 million returned to accrual status, offset by $5.3 million in loans moved to nonaccrual status. During the nine months ended September 30, 2015, loans past due 30-59 days decreased from $4.0 million at December 31, 2014 to $2.0 million at September 30, 2015.  Loans past due 60-89 days decreased from $980,000 at December 31, 2014 to $578,000 at September 30, 2015. This represents a $2.4 million decrease from December 31, 2014 to September 30, 2015 in loans past due 30-89 days.  We considered this trend in delinquency levels during the evaluation of qualitative trends in the portfolio when establishing the general component of our allowance for loan losses.

 

Non-Performing AssetsNon-performing assets consist of loans past due 90 days or more still on accrual, loans on which interest is no longer accrued, real estate acquired through foreclosure, and repossessed assets. The following table sets forth information with respect to non-performing assets as of September 30, 2015 and December 31, 2014.

 

   

September 30,

2015

   

December 31,

2014

 
   

(dollars in thousands)

 
                 

Loans past due 90 days or more still on accrual

  $     $ 151  

Nonaccrual loans

    16,987       47,175  

Total non-performing loans

    16,987       47,326  

Real estate acquired through foreclosure

    29,177       46,197  

Other repossessed assets

           

Total non-performing assets

  $ 46,164     $ 93,523  
                 

Non-performing loans to total loans

    2.72

%

    7.57

%

Non-performing assets to total assets

    4.85

%

    9.19

%

Allowance for non-performing loans

  $ 393     $ 1,253  

Allowance for non-performing loans to non-performing loans

    2.31

%

    2.65

%

 

At September 30, 2015, nonperforming loans were $17.0 million, or 2.72% of total loans, compared with $47.3 million, or 7.57% of total loans at December 31, 2014, and $44.7 million, or 7.00% of total loans at September 30, 2014. Net loan charge-offs in the first nine months of 2015 totaled $3.0 million compared to $10.2 million for the first nine months of 2014. 

 

 

Troubled Debt Restructuring - A troubled debt restructuring (TDR) occurs when the Company has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty.  The majority of the Company’s TDRs involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period.  All TDRs are considered impaired, and the Company has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower. If the loan is considered collateral dependent, it is reported net of allocated reserves, at the fair value of the collateral less cost to sell.

 

We do not have a formal loan modification program. Rather, we work with individual borrowers on a case-by-case basis to facilitate the orderly collection of our principal and interest before a loan becomes a non-performing loan. If a borrower is unable to make contractual payments, we review the particular circumstances of the borrower’s situation and negotiate a revised payment stream. In other words, we identify performing borrowers experiencing financial difficulties, and through negotiations, we lower their interest rate, most typically on a short-term basis for three to six months. Our goal when restructuring a credit is to afford the borrower a reasonable period of time to remedy the issue causing cash flow constraints within their business so they can return to performing status over time.

 

Our loan modifications have taken the form of reduction in interest rate and/or curtailment of scheduled principal payments for a short-term period, usually three to six months, but in some cases until maturity of the loan. In some circumstances we restructure real estate secured loans in a bifurcated fashion whereby we have a fully amortizing “A” loan at a market interest rate and an interest-only “B” loan at a reduced interest rate. Our restructured loans are all collateral secured loans. If a borrower fails to perform under the modified terms, we place the loan(s) on nonaccrual status and begin the process of working with the borrower to liquidate the underlying collateral to satisfy the debt.

 

At September 30, 2015, we had 30 restructured loans totaling $21.4 million compared with 52 restructured loans totaling $42.5 million at December 31, 2014. In general, these loans were granted interest rate reductions to provide cash flow relief to borrowers experiencing cash flow difficulties.  Of these loans, three loans totaling approximately $3.6 million were also granted principal payment deferrals until maturity. There were no concessions made to forgive principal relative to these loans, although we have recorded partial charge-offs for certain restructured loans. In general, these loans are secured by first liens on 1-4 residential or commercial real estate properties, or farmland.  Restructured loans also include $694,000 of commercial loans. At September 30, 2015, $17.7 million of our restructured loans were accruing and $3.8 million were on nonaccrual compared with $22.0 million and $20.5 million, respectively, at December 31, 2014. There were no new TDRs during the first nine months of 2015 or 2014.    

 

The following table sets forth information with respect to TDRs, non-performing loans, real estate acquired through foreclosure, and other repossessed assets.

 

   

September 30,

2015

   

December 31,

2014

 
   

(dollars in thousands)

 
                 

Total non-performing loans

  $ 16,987     $ 47,326  

TDRs on accrual

    17,656       21,985  

Total non-performing loans and TDRs on accrual

  $ 34,643     $ 69,311  

Real estate acquired through foreclosure

    29,177       46,197  

Other repossessed assets

           

Total non-performing assets and TDRs on accrual

  $ 63,820     $ 115,508  
                 

Total non-performing loans and TDRs on accrual to total loans

    5.55

%

    11.09

%

Total non-performing assets and TDRs on accrual to total assets

    6.71

%

    11.35

%

 

We consider any loan that is restructured for a borrower experiencing financial difficulties due to a borrower’s potential inability to pay in accordance with contractual terms to be a troubled debt restructure.  Specifically, we consider a concession involving a modification of the loan terms, such as (i) a reduction of the stated interest rate, (ii) reduction or deferral of principal, or (iii) reduction or deferral of accrued interest at a stated interest rate lower than the current market rate for new debt with similar risk all to be troubled debt restructurings.  When a modification of terms is made for a competitive reason, we do not consider that to be a troubled debt restructuring.  A primary example of a competitive modification would be an interest rate reduction for a performing borrower’s loan to a market rate as the result of a market decline in rates. 

 

 

Management periodically reviews renewals/modifications of previously identified TDRs for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower would continue to comply with the terms of the loan after the date of the renewal/modification. In this instance, the TDR was originally considered a restructuring in a prior year as a result of a modification with an interest rate that was not commensurate with the risk of the underlying loan. Additionally, TDR classification can be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms that were considered to be at market for loans with comparable risk. Management expects the borrower will continue to perform under the re-modified terms based on the borrower’s past history of performance.

 

At September 30, 2015 and December 31, 2014, TDRs totaled $21.4 million and $42.5 million, respectively. During the nine months ended September 30, 2015, TDRs were reduced as a result of $15.9 million in payments, charge-offs of $1.7 million, and transfers to OREO of $3.5 million.

 

If the borrower fails to perform, we place the loan on nonaccrual status and seek to liquidate the underlying collateral for these loans. Our nonaccrual policy for restructured loans is identical to our nonaccrual policy for all loans. Our policy calls for a loan to be reported as nonaccrual if it is maintained on a cash basis because of deterioration in the financial condition of the borrower, payment in full of principal and interest is not expected, or principal or interest has been in default for a period of 90 days or more unless the assets are both well secured and in the process of collection. Changes in value for impairment, including the amount attributed to the passage of time, are recorded entirely within the provision for loan losses. Upon determination that a loan is collateral dependent, the loan is charged down to the fair value of collateral less estimated costs to sell.

 

See “Note 4 - Loans,” of the notes to the financial statements for additional disclosure related to troubled debt restructuring.

 

Allowance for Loan LossesThe allowance for loan losses is based on management’s continuing review and evaluation of individual loans, loss experience, current economic conditions, risk characteristics of various categories of loans and such other factors that, in management’s judgment, require consideration in estimating loan losses.

 

Management has established loan grading procedures that result in specific allowance allocations for any estimated inherent risk of loss.  For loans not individually evaluated, a general allowance allocation is computed using factors developed over time based on actual loss experience.  The specific and general allocations plus consideration of qualitative factors represent management’s best estimate of probable losses contained in the loan portfolio at the evaluation date.  Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses. 

 

 

An analysis of changes in the allowance for loan losses and selected ratios for the three and nine month periods ended September 30, 2015 and 2014, and for the year ended December 31, 2014 follows: 

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

   

Year Ended

December 31,

 
   

2015

   

2014

   

2015

   

2014

    2014  
   

(dollars in thousands)

 

Balance at beginning of period

  $ 16,809     $ 25,133     $ 19,364     $ 28,124     $ 28,124  
                                         

Loans charged-off:

                                       

Real estate

    1,254       1,548       4,138       12,272       17,943  

Commercial

    201       216       675       670       1,099  

Consumer

    70       59       200       238       354  

Agriculture

    41             111       30       30  

Other

    14       1       47       19        

Total charge-offs

    1,580       1,824       5,171       13,229       19,426  
                                         

Recoveries

                                       

Real estate

    1,049       742       1,591       2,481       2,726  

Commercial

    5       108       406       340       614  

Consumer

    98       23       158       134       213  

Agriculture

    2       2       5       11       13  

Other

    15       14       45       37        

Total recoveries

    1,169       889       2,205       3,003       3,566  

Net charge-offs

    411       935       2,966       10,226       15,860  

Provision (negative provision) for loan losses

    (2,200

)

          (2,200

)

    6,300       7,100  

Balance at end of period

  $ 14,198     $ 24,198     $ 14,198     $ 24,198     $ 19,364  
                                         

Allowance for loan losses to period-end loans

    2.27

%

    3.79

%

    2.27

%

    3.79

%

    3.10

%

Net charge-offs to average loans (annualized)

    0.25

%

    0.58

%

    0.62

%

    2.04

%

    2.39

%

Allowance for loan losses to non-performing loans

    83.58

%

    54.17

%

    83.58

%

    54.17

%

    40.92

%

                                         

Allowance for loan losses for loans individually evaluated for impairment

  $ 469     $ 1,788     $ 469     $ 1,788     $ 752  

Loans individually evaluated for impairment

    34,895       78,695       34,895       78,695       71,993  

Allowance for loan losses to loans individually evaluated for impairment

    1.34

%

    2.27

%

    1.34

%

    2.27

%

    1.04

%

                                         

Allowance for loan losses for loans collectively evaluated for impairment

  $ 13,729     $ 22,410     $ 13,729     $ 22,410     $ 18,612  

Loans collectively evaluated for impairment

    589,519       559,665       589,519       559,665       553,006  

Allowance for loan losses to loans collectively evaluated for impairment

    2.33

%

    4.00

%

    2.33

%

    4.00

%

    3.37

%

 

Our loan loss reserve, as a percentage of total loans at September 30, 2015, decreased to 2.27% from 3.79% at September 30, 2014, and from 3.10% at December 31, 2014.  The change in our loan loss reserve as a percentage of total loans between periods is attributable to the improving historical loss experience, qualitative factors, improvement in risk grade classification metrics, improving charge-off levels, and improving past due trends.  Our allowance for loan losses to non-performing loans was 83.58% at September 30, 2015, compared with 40.92% at December 31, 2014, and 54.17% at September 30, 2014. Net charge-offs in the first nine months of 2015 totaled $3.0 million. Gross charge-offs for the first nine months of 2015 totaled $5.2 million, of which $2.9 million were the result of charging off the allowance for individually evaluated loans deemed to be collateral dependent during the period.

 

 

The following table sets forth the net charge-offs (recoveries) for the periods indicated:

 

   

Nine Months Ended

September 30, 2015

   

Year Ended

December 31, 2014

   

Year Ended

December 31, 2013

 
   

(in thousands)

 

Commercial

  $ 269     $ 485     $ 1,616  

Commercial Real Estate

    1,258       11,878       20,045  

Residential Real Estate

    1,289       3,339       7,212  

Consumer

    42       167       507  

Agriculture

    106       17       (124

)

Other

    2       (26

)

     

Total net charge-offs

  $ 2,966     $ 15,860     $ 29,256  

 

The majority of our nonperforming loans are secured by real estate collateral, and the underlying collateral coverage for nonperforming loans supports the likelihood of collection of our principal. We have assessed these loans for collectability and considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure the allowance for loan losses is adequate to absorb probable incurred losses. Our allowance for non-performing loans was $393,000 or 2.31% of non-performing loans at September 30, 2015 compared with $1.3 million or 2.65% at December 31, 2014, and $1.2 million or 2.72% at September 30, 2014 as non-performing loan trends continue to improve.

 

The following table presents the unpaid principal balance, recorded investment and allocated allowance related to loans individually evaluated for impairment in the commercial real estate and residential real estate portfolios as of September 30, 2015 and December 31, 2014.

 

   

September 30, 2015

   

December 31, 2014

 
   

Commercial

Real Estate

   

Residential

Real Estate

   

Commercial

Real Estate

   

Residential

Real Estate

 
   

(in thousands)

 

Unpaid principal balance

  $ 21,949     $ 21,257     $ 65,899     $ 24,633  

Prior charge-offs

    (7,039

)

    (2,779

)

    (17,758

)

    (3,249

)

                                 

Recorded investment

    14,910       18,478       48,141       21,384  

Allocated allowance

    (65

)

    (404

)

    (491

)

    (227

)

                                 

Recorded investment, less allocated allowance

  $ 14,845     $ 18,074     $ 47,650     $ 21,157  
                                 

Recorded investment, less allocated allowance/ Unpaid principal balance

    67.63

%

    85.03

%

    72.31

%

    85.89

%

 

Based on previous charge-offs, our current recorded investment in the commercial real estate and residential real estate segments is significantly below the unpaid principal balance for these loans. The recorded investment and allocated allowance were 67.63% and 85.03% of the unpaid principal balance in the commercial real estate and residential real estate segments of the portfolio, respectively, at September 30, 2015.

 

The following table illustrates recent trends in loans collectively evaluated for impairment and the related allowance for loan losses by portfolio segment:

 

   

September 30, 2015

   

June 30, 2015

   

March 31, 2015

   

December 31, 2014

 
   

Loans

   

Allowance

   

% to Total

   

Loans

   

Allowance

   

% to Total

   

Loans

   

Allowance

   

% to

Total

   

Loans

   

Allowance

   

% to Total

 
                                                                                                 

Commercial

  $ 83,578     $ 1,570       1.88

%

  $ 77,187     $ 1,945       2.52

%

  $ 75,277     $ 2,044       2.72

%

  $ 58,914     $ 2,013       3.42

%

Commercial real estate

    239,143       7,951       3.32       249,989       8,542       3.42       241,286       10,629       4.41       237,903       10,440       4.39  

Residential real estate

    225,410       3,825       1.70       231,538       4,890       2.11       220,229       5,021       2.28       217,785       5,560       2.55  

Consumer

    10,458       181       1.73       9,938       226       2.27       10,799       243       2.25       11,286       273       2.42  

Agriculture

    30,457       200       0.66       30,161       359       1.19       28,441       391       1.37       26,703       319       1.19  

Other

    473       2       0.42       497       5       1.01       1,097       15       1.37       415       7       1.69  

Total

  $ 589,519     $ 13,729       2.33

%

  $ 599,310     $ 15,967       2.66

%

  $ 577,129     $ 18,343       3.18

%

  $ 553,006     $ 18,612       3.37

%

  

 

Our allowance for loan losses for loans collectively evaluated for impairment declined to 2.33% at September 30, 2015 from 4.00% at September 30, 2014 and 3.37% at December 31, 2014. This decline was driven primarily by an improving loan risk category classification mix and volume as well as improving historical loss trends which are key factors for estimating general reserves. Other factors include the consideration of growth, composition and diversification of our loan portfolio, current delinquency levels, the results of recent regulatory communications and general economic conditions.

 

Provision for Loan LossesA negative provision of $2.2 million was recorded for the first nine months of 2015 compared to $6.3 million of provision expense for the first nine months of 2014. The $2.2 million negative provision in the third quarter was primarily driven by declining historical loss rates, improvements in asset quality, and management’s assessment of risk in the portfolio. Substandard loans decreased by $21.5 million or 31.2% over the past quarter and $44.0 million or 48% over the first nine months of 2015, net charge-offs were $3.0 million for the first nine months of 2015 compared to $10.2 million for the first nine months of 2014 and $411,000 for the third quarter of 2015 compared to $1.8 million in the second quarter of 2015, and nonaccrual loans decreased by $13.2 million or 43.8% over the past quarter and $30.2 million or 64.0% over the first nine months of 2015. We consider the size and volume of our portfolio as well as the credit quality of our loan portfolio based upon risk category classification when determining the loan loss provision for each period and the allowance for loan losses at period end.

 

Foreclosed Properties – Foreclosed properties at September 30, 2015 were $29.2 million compared with $54.5 million at September 30, 2014 and $46.2 million at December 31, 2014.  See “Note 5 - Other Real Estate Owned,” of the notes to the financial statements. During the first nine months of 2015, we acquired $4.5 million of OREO properties and sold properties totaling approximately $14.4 million. We value foreclosed properties at fair value less estimated costs to sell when acquired and expect to liquidate these properties to recover our investment in the due course of business.

 

OREO is recorded at fair market value less estimated cost to sell at time of acquisition.  Any write-down of the property at the time of acquisition is charged to the allowance for loan losses.  Subsequent reductions in fair value are recorded as non-interest expense.  To determine the fair value of OREO for smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers.  If the internally evaluated market price is below our underlying investment in the property, appropriate write-downs are recorded. 

 

For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property or have staff in our special assets group or centralized appraisal department evaluate the latest in-file appraisal in connection with the transfer to OREO.  In some of these circumstances, an appraisal is in process at quarter end and we must make our best estimate of the fair value of the underlying collateral based on our internal evaluation of the property, our review of the most recent appraisal, and discussions with the currently engaged appraiser.  We typically obtain updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. When an asking price is lowered below the most recent appraised value, appropriate write-downs are taken.

 

Net gain (loss) on sales, write-downs, and operating expenses for OREO totaled $8.8 million for the nine months ended September 30, 2015, compared with $2.0 million for the same period of 2014. During the nine months ended September 30, 2015, fair value write-downs of $7.1 million were recorded to reflect declines in the fair value of the real estate based upon reductions in listing prices for certain properties, updated appraisals, and properties liquidated through auctions near and after the end of the third quarter, compared with $1.3 million for the nine months ended September 30, 2014. Late in the third quarter of 2015, the Bank determined to liquidate 18 parcels of OREO with an aggregate book value at that time of $4.0 million through absolute auctions. The auctions resulted in final bids less estimated selling costs of $1.8 million. Fair value write-downs of $2.2 million were recorded in the third quarter of 2015 related to these properties and cash settlement is expected to occur in the fourth quarter of 2015. At quarter end, $6.5 million of OREO property was subject to a contract for sale or letter of intent including the $1.8 million in estimated net proceeds resulting from the auctions discussed above.

 

Given the current size of the OREO portfolio, OREO expenses may be elevated in future periods as we work to sell these properties. Additionally, nonaccrual loans totaled $17.0 million at September 30, 2015, and we expect to resolve certain of these loans by foreclosure which may result in further additions to our OREO portfolio.

 

LiabilitiesTotal liabilities at September 30, 2015 were $917.7 million compared with $984.5 million at December 31, 2014, a decrease of $66.9 million, or 6.8%. This decrease was primarily attributable to a decrease in deposits of $48.9 million from $926.8 million at December 31, 2014 to $877.9 million at September 30, 2015, a decrease in Federal Home Loan Bank advances of $12.5 million and a decrease of $4.0 million in junior subordinated debentures due to the debt to equity transaction on September 30, 2015. Federal Home Loan Bank advances are used from time to time to fund asset growth and manage interest rate risk in accordance with our asset/liability management strategies. 

 

 

Deposits are our primary source of funds. The following table sets forth the average daily balances and weighted average rates paid for our deposits for the periods indicated:

 

   

For the Nine Months

   

For the Year

 
   

Ended September 30,

   

Ended December 31,

 
   

2015

   

2014

 
   

Average

   

Average

   

Average

   

Average

 
   

Balance

   

Rate

   

Balance

   

Rate

 
   

(dollars in thousands)

 

Demand

  $ 112,326             $ 113,150          

Interest checking

    87,413       0.13

%

    83,504       0.15

%

Money market

    108,474       0.56       96,194       0.55  

Savings

    36,003       0.22       36,803       0.24  

Certificates of deposit

    572,243       0.97       632,020       1.29  

Total deposits

  $ 916,459       0.70

%

  $ 961,671       0.92

%

 

The following table sets forth the average daily balances and weighted average rates paid for our certificates of deposit for the periods indicated:

 

   

For the Nine Months

   

For the Year

 
   

Ended September 30,

   

Ended December 31,

 
   

2015

   

2014

 
   

Average

   

Average

   

Average

   

Average

 
   

Balance

   

Rate

   

Balance

   

Rate

 
   

(dollars in thousands)

 

Less than $100,000

  $ 312,772       0.94

%

  $ 354,250       1.22

%

$100,000 or more

    259,471       1.01       277,770       1.37  

Total

  $ 572,243       0.97

%

  $ 632,020       1.29

%

 

The following table shows at September 30, 2015 the amount of our time deposits of $100,000 or more by time remaining until maturity (in thousands):

  

Maturity Period

 
         

Three months or less

  $ 53,113  

Three months through six months

    36,668  

Six months through twelve months

    62,584  

Over twelve months

    89,665  

Total

  $ 242,030  

 

 

Liquidity

 

Liquidity risk arises from the possibility we may not be able to satisfy current or future financial commitments, or may become unduly reliant on alternative funding sources. The objective of liquidity risk management is to ensure we meet the cash flow requirements of depositors and borrowers, as well as our operating cash needs, taking into account all on- and off-balance sheet funding demands. Liquidity risk management also involves ensuring we meet our cash flow needs at a reasonable cost. We maintain an investment and funds management policy, which identifies primary sources of liquidity, establishes procedures for monitoring and measuring liquidity, and establishes minimum liquidity requirements in compliance with regulatory guidance. Our Asset Liability Committee regularly monitors and reviews our liquidity position.

 

Funds are available from a number of sources, including the sale of securities in the available for sale portion of the investment portfolio, principal pay-downs on loans and mortgage-backed securities, customer deposit inflows, and other wholesale funding. Our available for sale investment portfolio totaled $146.8 million at September 30, 2015 and within that portfolio, $32.2 million of our securities currently have an unrealized loss of $432,000.

 

Traditionally, we have borrowed from the FHLB to supplement our funding requirements. The advances are collateralized by first mortgage residential loans. The borrowing capacity is based on the market value of the underlying pledged loans. At September 30, 2015, our additional borrowing capacity with the FHLB was $25.7 million. Any new advances are limited to a one year maturity or less. The availability of our borrowing capacity could be affected by our financial condition and the FHLB could require additional collateral or, among other things, exercise its right to deny a funding request, at its discretion.

 

We also have federal funds borrowing lines from correspondent banks totaling $5.0 million on a secured basis. Management believes our sources of liquidity are adequate to meet expected cash needs for the foreseeable future. However, the availability of these lines could be affected by our financial position, and our lenders could exercise their right to deny a funding request at their discretion. We are also subject to FDIC interest rate restrictions for deposits. As such, we are permitted to offer up to the “national rate” plus 75 basis points as published weekly by the FDIC. We are also precluded from accepting brokered deposits without the pre-approval of our primary regulators.

 

We use cash to pay dividends on common stock, if and when declared by the Board of Directors, and to service debt. The main sources of funding for the Company include dividends paid by the Bank and financing obtained in the capital markets. During 2011, the Company contributed $13.1 million to the Bank which substantially decreased its liquid assets. The contribution was made to strengthen the Bank’s capital in an effort to help it comply with its capital ratio requirements under the consent order. The Company’s liquid assets decreased from $20.3 million at December 31, 2010, to $1.2 million at September 30, 2015. Since the Bank is unlikely to be in a position to pay dividends to the parent company for the foreseeable future, cash inflows for the parent are limited to earnings on investment securities, sales of investment securities, and interest on deposits with the Bank. Ongoing cash operating expenses of the parent company are expected to be approximately $1.0 million over the next twelve months. We have elected to defer payments on our trust preferred securities.  

 

 

Capital

 

In the fourth quarter of 2011, we began deferring interest payments on our junior subordinated notes, which resulted in a deferral of distributions on our trust preferred securities. Therefore, we will not be able to pay cash dividends on our common shares until such time that we have paid all deferred distributions on our trust preferred securities. If we defer interest payments on our trust preferred securities for 20 consecutive quarters (through September 30, 2016), we must pay all deferred interest or we will be in default. At September 30, 2015, cumulative accrued and unpaid interest on our junior subordinated notes totaled $2.3 million.

 

Stockholders’ equity increased $343,000 to $33.8 million at September 30, 2015, compared with $33.5 million at December 31, 2014 due to the issuance of common stock related to the retirement of $4.0 million of the Company’s junior subordinated debt. This increase in common stock was offset by current year net loss of $2.6 million, and a decrease in the fair value of our available for sale securities portfolio of $805,000.

 

On February 25, 2015, shareholders approved the conversion of all mandatorily convertible Series B Preferred Shares into 4,053,600 common shares and the conversion of all mandatorily convertible Series D Preferred Shares into 6,458,000 non-voting common shares. The conversion reduced preferred stockholders’ equity by $5.8 million and increased common stockholders’ equity by the same amount. Total issued and outstanding common shares and non-voting common shares were 26,949,205 at September 30, 2015.

 

On September 30, 2015, we completed a common equity for debt exchange with holders of $4.0 million of the capital securities (the “Trust Securities”) of Porter Statutory Trust IV, a trust subsidiary of the Company. Accrued and unpaid interest on the Trust Securities totaled approximately $330,000. In exchange for the $4.3 million debt and interest liability, the Company issued 800,000 common shares and 400,000 non-voting common shares, for a total of 1,200,000 shares. In the transaction, a wholly owned subsidiary of the Company received a one-third portion of the Trust Securities directly from an unrelated third party in exchange for 400,000 common shares, resulting in an $883,000 gain on extinguishment of debt. The subsidiary also received two-thirds of the Trust Securities from related parties in exchange for 400,000 common shares and 400,000 non-voting common shares. The debt and interest liability exchanged with related parties was treated as a capital transaction.

 

Each of the federal bank regulatory agencies has established risk-based capital requirements for banking organizations. The Basel III regulatory capital reforms became effective for the Company and Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios.  These rules refine the definition of what constitutes “capital” for purposes of calculating those ratios, including the definitions of Tier 1 capital and Tier 2 capital. The final rules allowed banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company and the Bank opted out of this requirement. In addition, the Bank has agreed with its primary regulators to maintain a ratio of total capital to total risk-weighted assets (“total risk-based capital ratio”) of at least 12.0%, and a ratio of Tier 1 capital to total assets (“leverage ratio”) of 9.0%.

 

The following table shows the ratios of Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for the Company and the Bank at the dates indicated:

 

                           

September 30, 2015

   

December 31, 2014

 
   

Regulatory Minimums

   

Well-Capitalized

Minimums

   

Minimum Capital

Ratios Under

Consent Order

   

Porter

Bancorp

   

PBI

Bank

   

Porter

Bancorp

   

PBI

Bank

 
                                                         

Tier 1 Capital

    6.0%       8.0%    

N/A

      6.86%       8.73%       6.70%       8.59%  

Common equity Tier I capital

    4.5       6.5    

N/A

      5.07       8.73    

  N/A

   

  N/A

 

Total risk-based capital

    8.0       10.0     12.0%       10.40       10.50       10.61       10.57  

Tier 1 leverage ratio

    4.0       5.0     9.0       4.73       6.01       4.51       5.78  

 

 

At September 30, 2015, the Bank’s Tier 1 leverage ratio was 6.01%, and its total risk-based capital ratio was 10.50%, both of which are below the minimum capital ratios required by the Consent Order. Failure to meet minimum capital requirements could result in additional discretionary actions by regulators that, if undertaken, could have a materially adverse effect on our financial condition. 

 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

The Company’s interest sensitivity profile was liability sensitive at September 30, 2015 and December 31, 2014. Given a 100 basis point increase in interest rates sustained for one year, base net interest income would decrease by an estimated 0.82% at September 30, 2015, compared with a decrease of 3.15% at December 31, 2014, and is within the risk tolerance parameters of our risk management policy. Given a 200 basis point increase in interest rates sustained for one year, base net interest income would decrease by an estimated 1.44% at September 30, 2015, compared with a decrease of 5.86% at December 31, 2014, and also is within the risk tolerance parameters of our risk management policy.

 

The following table indicates the estimated impact on net interest income under various interest rate scenarios for the twelve months following September 30, 2015, as calculated using the static shock model approach:

 

   

Change in Future

Net Interest Income

 
   

Dollar

Change

   

Percentage

Change

 
   

(dollars in thousands)

 

+ 200 basis points

  $ (399

)

    (1.44

)%

+ 100 basis points

    (227

)

    (0.82

)

 

We did not run a model simulation for declining interest rates as of September 30, 2015 because the Federal Reserve effectively lowered the federal funds target rate from between 0.00% to 0.25% in December 2008.  Therefore, no significant further short-term rate reductions can occur. 

 

Item 4. Controls and Procedures

 

Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of September 30, 2015, an evaluation was performed under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures.

 

Management determined that a material weakness existed in the Company’s internal control over financial reporting at June 30, 2014. The Company utilized information to record the fair value of other real estate owned at June 30, 2014 which was obtained prior to taking possession of commercial real estate through a settlement agreement with a contentious borrower on June 24, 2014, rather than promptly obtaining new information material to the fair value of the properties before the filing of the financial statements as of and for the three and six month periods ended June 30, 2014. We determined, after the filing of those financial statements, that our initial estimate of fair value was significantly higher than the actual fair value as it was not based upon the best information available. Based upon the restatement of the Company’s financial statements as of and for the three and six month periods ended June 30, 2014, the Company determined that our internal controls for recording other real estate owned at estimated fair value less costs to sell did not in this instance establish an accurate initial book value and were not effective. Our management, overseen by the Audit Committee, worked throughout the fourth quarter of 2014 to implement controls, procedures, and processes to remediate this control weakness.

 

These enhanced controls, procedures, and process improvements include:

 

 

The Special Assets Group promptly and thoroughly reviews new information material to the fair value of the property and analyzes key assumptions relevant to the fair value conclusion and cost to sell estimate. New information includes, but it not limited to, updated appraisals, site visits performed by the Special Assets Group, and discussions with current tenants.

 

 

Personnel, including senior management, consult with the Special Assets Group and external experts, such as property management professionals, to evaluate the new information material to the fair value of the property including comparable sales, income and expenses, and other relevant valuation factors.

 

 

Finance and accounting personnel engage in detailed discussions regarding valuation issues and review other real estate owned, including additions, with the Special Assets Group throughout each reporting period and through the subsequent period up to the filing of the financial statements.

 

During the fourth quarter of 2014 and throughout the first nine months of 2015, we took steps to resolve the material weakness by changing our controls, procedures, and processes for recording other real estate owned at estimated fair value less cost to sell, as discussed above. Based on our evaluation, management including our Chief Executive Officer and our Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report. There were no other changes in our internal control over financial reporting that occurred during the nine months ended September 30, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

  

PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

 

We are defendants in various legal proceedings.  Litigation is subject to inherent uncertainties and unfavorable outcomes could occur. See Footnote 13, “Contingencies” in the Notes to our consolidated financial statements for additional detail regarding ongoing legal proceedings.

 

Item 1A. Risk Factors

 

We refer you to the detailed cautionary statements and discussion of risks that affect our Company and its business in “Item 1A – Risk Factors” of our December 31, 2014 Annual Report on Form 10-K. There have been no material changes from the risk factors previously discussed in those reports.

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

Not applicable.

 

Item 3. Default Upon Senior Securities

 

Not applicable.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

Not applicable

 

Item 6. Exhibits

 

(a)           Exhibits

The following exhibits are filed or furnished as part of this report:

 

Exhibit Number

Description of Exhibit

  

10.1

Exchange Agreement with Patriot Financial Partners, L.P dated September 30, 2015 (incorporated by reference to Exhibit 10.1 to Form 8-K filed October 2, 2015).

   

10.2

Exchange Agreement with W. Glenn Hogan dated September 30, 2015 (incorporated by reference to Exhibit 10.2 to Form 8-K filed October 2, 2015).

   

10.3

Consent Order dated November 12, 2015.

   

31.1

Certification of Principal Executive Officer, pursuant to Rule 13a - 14(a).

  

31.2

Certification of Principal Financial Officer, pursuant to Rule 13a - 14(a).

  

32.1

Certification of Principal Executive Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

  

32.2

Certification of Principal Financial Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

101

The following financial statements from the Company’s Quarterly Report on Form 10Q for the quarter ended September 30, 2015, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statement of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, (vi) Notes to Consolidated Financial Statements.

  

  

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act if 1934, the Registrant had duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. 

 

 

PORTER BANCORP, INC.

 

  (Registrant)  

 

 

 

 

November 12, 2015

By:

/s/ John T. Taylor

 

 

 

John T. Taylor

 

 

 

Chief Executive Officer

 

       
November 12, 2015 By: /s/ Phillip W. Barnhouse  
    Phillip W. Barnhouse   
    Chief Financial Officer  

 

 

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